BANKING 

WILLIAM  A.  SCOTT 


UNIVERSITY  OF  CALIFORNIA 
AT    LOS  ANGELES 


The  National  Social  Science  Series 

Edited  by  Frank  L.  McVey,  Ph.D.,  LL.D., 
President  of  the 
University  of  North  Dakota 

Now  Ready 

MONEY.  William  A.  Scott,  Director  of  the  Course 
in  Commerce,  and  Professor  of  Political  Economy, 
University  of  Wisconsin 

TAXATION.  C.  B.  Fillebrown,  President  Massa- 
chusetts Single  Tax  League,  Author  of  A  B  C  of 
Taxation 

THE  FAMILY  AND  SOCIETY.  John  M.  Gillette, 
Professor  of  Sociology,  University  of  North  Dakota 

BANKING.    William  A.  Scott 

In  Preparation 

THE  CITY.    Henry  C.  Wright 

TRUSTS  AND  COMPETITION.    John  F.  Crowell 

THE  COST  OF  LIVING.    Walter  E.  Clark 

STATISTICS.    W.  B.  Bailey 

BASIS  OF  COMMERCE.    E.  V.  Robinson 

PUBLIC  FINANCE.    Carl  C.  Plehn 

Each,  Fifty  Cents  Net 
A.  C.  McCLURG  &  CO.,  PUBLISHERS,  CHICAGO 


BANKING 


BY 

William  A.  Scott,  Ph.D.,  LL.D. 

Director  of  the  Course  in  Commerce  and  Professor  of 
Political  Economy  in  the  University  of  Wisconsin 


CHICAGO 

A.  C.  McCLURG  &  CO. 

1914 


Copyright 
A.  C.  McCLURG  &  CO. 

1914 


Published  April,  1914 


Copyrighted  in  Great  Britain 


MALL  PRINTING  COMPANY,  CHICAGO 


3  C~ 


EDITOR'S  PREFACE 

In  Europe  the  average  man  looks  upon  the 
bank  as  a  benefactor.  Through  its  agency 
he  secures  capital  at  low  rates  for  his  busi- 
ness. In  America  the  bank  is  too  often  re- 
garded as  a  necessary  evil,  certainly  not  with 
affection.  Yet  it  plays  a  most  important  role 
in  the  nation's  economy.  Our  banking  laws 
are  obsolete,  unsatisfactory,  and  actually  in 
some  instances  detrimental  to  the  best  and 
widest  use  of  the  nation's  resources.  Europe 
'  has  many  lessons  for  us  in  the  problem  of  how 
best  to  use  our  accumulations.  With  agricul- 
ture demanding  and  the  railroads  calling  for 
more  capital,  the  question  of  scientific  bank- 
ing assumes  new  proportions.  This  book,  with 
■^  its  chapters  on  commercial  and  investment 
\\>  banking,  will  help  to  a  better  knowledge. 

F.  L.  M. 


33 


AUTHOR'S  PREFACE 

The  purpose  of  this  book  is  to  supply  the 
general  reader  with  a  simple  statement  of  the 
principles  and  problems  of  banking.  Since 
it  is  designed  primarily  for  American  readers, 
special  attention  has  been  given  to  conditions 
in  this  country.  An  effort  has  been  made 
clearly  to  draw  the  line  between  commercial 
and  investment  banking  and  to  indicate  the 
problems  peculiar  to  each.  That  it  may  assist 
the  average  person  in  understanding  present- 
day  banking  problems  and  thus  contribute  to- 
wards the  formation  of  a  sound  public  opinion 
regarding  them,  is  the  author's  hope  and 
desire. 

Wm.  A.  Scott. 
University  of  Wisconsin. 


CONTENTS 

PAGE 

Chapter  I.    The  Nature,  Functions,  and  Classifi- 
cation of  Banking  Institutions 1 

1.  Services    Performed    by    Banking   Insti- 

tutions         1 

2.  The  Economic  Functions  of  Banks     .     .  4 

3.  Classification  of  Banking  Institutions     .  6 

Chapter    II.     The    Nature    and    Operations    of 

Commercial  Banking 11 

1.  Commercial  Paper 11 

2.  The  Operation  of  Discount 13 

3.  The  Conduct  of  Checking  Accounts     .     .  15 

4.  The  Issue  of  Notes t    .  19 

5.  Collections 22 

6.  Domestic  Exchange 25 

7.  Foreign   Exchange       31 

Chapter    III.      The    Problems    of    Commercial 

Banking 35 

1.  The  Supply  of  Cash 35 

2.  The  Selection  of  Loans  and  Discounts    .  40 

3.  Rates 44 


Contents 

PAGE 

4.  Protection   against   Unsound   Practices  .  46 

(a)  Capital  and  Surplus  Requirements 

and   Double   Liability  of  Stock- 
holders      46 

(b)  Inflation    and    Means   of   Protect- 

ing the  Public  against  It  ...  49 

(c)  Other  Means  of  Safeguarding  the 

Interests  of  the  Public    ....  59 

5.  Adequacy  and  Economy  of  Service     .     .  62 

Chapter  IV.    Commercial  Banking  in  the  United 

States 68 

1.  State  Banks 68 

2.  National  Banks 70 

3.  The  Independent  Treasury  System     .     .  75 

4.  The  Interrelations  of  These  Institutions  .  78 

5.  Operation  of  the  System 82 

(a)  Conflict  of  Functions  and  Laws     .  82 

(b)  Loan  Operations 85 

(c)  Treasury   Operations 88 

(d)  Operation  of  the  Reserve  System  .  91 

(e)  Lack  of  Elasticity  in  the  Currency  95 

6.  Plans  for  Reform 97 

Chapter    V.      Commercial    Banking    in    Other 

Countries 101 

1.     Common  Features 101 


Contents 

PAGE 

2.  The  English  System 104 

3.  The  French  System Ill 

4.  The  German  System 119 

5.  The   Canadian   System 126 

Chapter  VI.     Investment  Banking 136 

1.  Saving  and   Savings   Institutions     .     .     .  136 

2.  Trust   Companies 141 

3.  Bond  Houses  and  Investment  Companies  144 

4.  Land  Banks 147 

5.  Stock  Exchanges 163 

6.  Some  Defects  in  Our  Investment  Bank- 

ing Machinery 166 

References 171 

Index 173 


BANKING 

CHAPTER  I 

The  Nature,  Functions,  and  Classifica- 
tion of  Banking  Institutions 

>"pHE  terms,  "bank"  and  "banking,"  are 
-*■  applied  to  institutions  and  to  businesses 
which  differ  considerably  in  character,  func- 
tions, and  methods,  but  which  nevertheless 
have  certain  common  features  which  justify 
their  being  grouped  together.  We  can  best 
prepare  the  way  for  a  discussion  of  these 
differences  and  common  features  by  a  descrip- 
tion of  the  services  which  these  institutions 
perform  in  modern  society. 

i.  Services  Performed  by  Banking 
Institutions 

From  the  point  of  view  of  their  customers 
these  services  may  be  grouped  under  the  fol- 
lowing heads :  The  safekeeping  of  money  and 
other  valuables ;  the  making  of  payments ;  the 
making  of  loans;  and  the  making  of  invest- 
I 


2  Banking 

ments.  It  is  a  common  practice  everywhere, 
and  in  some  countries,  notably  the  United 
States,  almost  a  universal  practice  for  people 
to  intrust  their  money  to  banks  for  safekeeping. 
To  a  degree,  hoarding,  in  the  sense  of  locking 
up  money  in  private  vaults  and  other  recep- 
tacles and  keeping  it  under  the  eye  and  in  the 
personal  care  of  the  owner,  is  still  practiced, 
but  it  is  doubtless  on  the  wane  in  all  civilized 
countries.  The  practice  of  intrusting  to  banks 
the  safekeeping  of  other  valuables,  such  as 
important  documents,  jewelry,  plate,  etc.,  is 
also  widespread  and  growing. 

The  service  of  the  safekeeping  of  money 
naturally  leads  to  the  second,  the  making  of 
payments.  When  we  intrust  our  means  of  pay- 
ment to  a  bank,  it  is  natural  that  we  should 
also  make  it  our  treasurer  and  disbursing 
agent,  and  so  we  do.  If  we  have  payments 
to  make  to  people  at  home,  in  other  cities  of 
our  own  country,  or  in  other  countries,  we 
usually  order  our  bank  to  perform  the  service 
for  us. 

Loans  of  almost  all  kinds  are  made  by  banks, 
and  certain  kinds,  namely,  those  to  business 
men  for  the  everyday  conduct  of  commerce 
and  industry,  are  made  almost  exclusively  by 
them.     For  the  most  part  these  are  short-term 


Banking  Institution* 


loans.  For  long-term  loans  banks  are  also 
one  of  the  chief  resorts,  but  in  some  countries 
these  are  not  to  so  great  a  degree  monopolized 
by  them  as  the  short-term  variety. 

For  the  investment  of  the  surplus  funds  of 
people  banks  are  the  chief  agencies.  This  func- 
tion takes  the  form  mainly  of  the  sale  of 
stocks,  bonds,  and  mortgages,  and  sometimes 
of  the  promotion  of  new  enterprises. 

None  of  these  services  are  performed  by  banks 
exclusively.  For  the  safekeeping  of  valuables, 
and  sometimes  of  money,  there  are  in  some 
places  safe  deposit  companies  to  which  the 
term  "banks"  is  not  applied.  In  the  making 
of  payments  the  postoffice  departments  of  gov- 
ernments and  express  companies  participate, 
and  in  the  making  of  loans  and  investments 
brokers,  loan  companies,  lawyers,  etc.,  partici- 
pate. The  peculiarity  of  banking  institutions 
consists  not  in  the  performance  of  any  one  of 
these  services,  but  in  the  fact  that  they  spe- 
cialize in  them  all,  or  in  a  combination  of  them. 
Merely  to  keep  money  and  valuables  on  deposit, 
or  to  act  as  paymaster,  or  to  make  loans,  or 
to  sell  bonds,  stocks,  and  mortgages  would  not 
make  an  institution  a  bank  or  an  individual  a 
banker;  but  to  make  a  business  of  performing 
most  or  all  of  these  services   for  the  public 


4  Banking 

involves  the  use  of  certain  machinery  and  cer- 
tain methods  of  procedure,  and  the  assumption 
of  a  role  in  the  nation's  economy  which  is  dis- 
tinctive and  peculiar,  and  which  has  set  these 
institutions  apart  in  every  country  as  objects 
of  legislation  and  of  scientific  treatment,  as 
well  as  in  the  thought  and  regard  of  the  people. 

2.  The  Economic  Functions  of  Banks 

Viewed  from  the  standpoint  of  the  nation 
rather  than  from  that  of  individuals,  the  func- 
tions of  banks  may  be  described  as  those  of 
intermediaries  in  exchanges  and  in  the  invest- 
ment of  capital.  In  the  former  capacity  they 
supply  the  world  with  the  major  part  of  its 
medium  of  exchange  and  serve  as  distributing 
agents  for  that  portion  of  the  supply  which 
comes  from  other  sources.  They  create  a 
medium  of  exchange  through  a  process  of 
bookkeeping  which  is  world-wide  in  extent, 
and  through  which  the  mutual  indebtedness  of 
individuals,  cities,  and  other  subdivisions  of 
countries  and  nations,  brought  about  by  pur- 
chases and  sales  on  credit,  are  offset  without 
the  use  of  money. 

The  practice  of  depositing  surplus  funds 
with  banks  for  safekeeping  and  consequently 


Banking  Institutions 


of  using  them  as  paymasters  has  resulted  in  the 
reliance  of  everybody  upon  banks  for  currency 
in  any  form,  and  has  thus  thrown  upon  them 
the  responsibility  of  directly  utilizing  all  the 
sources  of  money  supply.  Thus  while  the 
mints  of  the  United  States  and  most  other 
countries  coin  gold  bullion,  and  supply  sub- 
sidiary silver  and  copper  and  nickel  coins  to 
private  persons  on  the  same  terms  as  to  banks, 
as  a  matter  of  fact  few  private  persons  take 
advantage  of  this  privilege,  finding  it  more 
convenient  and  profitable  to  get  the  coin  they 
want  from  banks.  The  same  is  true  of  govern- 
ment notes  in  countries  in  which  such  notes 
constitute  a  portion  of  the  currency. 

The  accumulation  of  a  nation's  capital 
and  its  investment  require  the  cooperation  of 
numerous  agencies  of  which  banks  are  the 
chief.  They  collect  the  savings  of  the  people, 
combine  them  into  amounts  of  sufficient  size 
for  investment  purposes,  and  invest  them 
temporarily  and  sometimes  permanently.  Coop- 
erating agencies  in  this  work  are  insurance 
companies,  societies  of  various  kinds  for  the 
promotion  of  saving,  stock  exchanges,  pro- 
moters, etc.  Some  of  these  take  the  place  of 
banks  in  the  performance  of  these  services, 
while  others  supplement  and  aid  them. 


Banking 


$.  Classification  of  Banking  Institutions 

Banks  differ  from  one  another  chiefly  in 
the  nature  and  degree  of  their  specialization, 
in  legal  status,  and  in  the  place  they  occupy 
in  the  system  to  which  they  belong.  Some 
banks  devote  the  major  portion  of  their  effort 
to  the  conduct  of  exchanges  and  are  called 
commercial  banks,  others  to  investment  bank- 
ing and  are  called  investment  banks.  The 
most  common  subclasses  under  the  latter 
head  are  savings  banks,  land  or  mortgage 
banks,  and  bond  houses.  Savings  banks 
specialize  in  the  collection  and  investment  of 
small  savings;  land  banks  are  primarily  inter- 
mediaries between  capitalists  and  people  who 
wish  to  invest  capital  in  land,  building  opera- 
tions, and  agriculture ;  and  bond  houses  are 
intermediaries  between  capitalists  and  those 
who  wish  to  invest  capital  in  industrial,  com- 
mercial, and  transportation  enterprises,  or  loan 
it  to  states,  cities,  or  other  public  corporations. 

Commercial  banks  rarely  confine  themselves 
exclusively  to  the  conduct  of  exchanges.  Most 
of  them  also  conduct  savings  departments  and 
invest  the  funds  intrusted  to  them  through 
such  departments  in  agricultural,  industrial,  or 


Banking  Institutions 


commercial  enterprises  or  loan  them  to  public 
corporations.  Commercial  banking,  however, 
is  their  main  concern,  their  other  departments 
being  side  issues  of  greater  or  less  importance 
according  to  circumstances.  Investment  banks 
also  frequently  carry  on  commercial  banking 
as  a  side  issue.  These  two  lines  of  business 
are  sometimes  mixed  in  such  proportions  as 
to  render  classification  difficult. 

From  a  legal  point  of  view  the  banks  of 
nearly  all  countries  may  be  classified  as 
private  or  unincorporated,  and  incorporated, 
sometimes  also  called  joint-stock  banks. 
Private  banks  are  started  by  individuals  or 
firms,  like  any  other  private  enterprise,  with- 
out the  formality  of  application  for  permission 
to  some  public  officer,  and  without  compliance 
with  a  set  of  legally  prescribed  regulations. 
They  are  subject  to  the  laws  of  the  country 
governing  all  kinds  of  private  business  enter- 
prises and  sometimes  to  special  laws  applying 
specifically  to  them.  In  some  of  the  states  of 
the  United  States  such  banks  are  prohibited 
by  law. 

Incorporated  banks  are  usually  started  by 
private  initiative  but  owe  their  actual  legal 
existence  and  status  to  a  special  law,  to  the 
requirements    of    which    they    must    conform 


8  Banking 

before  they  are  permitted  to  do  business.  Their 
right  to  do  business  is  usually  evidenced  by  a 
document  known  as  a  charter,  executed  and 
delivered  by  a  public  officer  legally  endowed 
with  the  requisite  authority,  or  passed  in  the 
form  of  a  law  by  the  legislative  organs  of  the 
state.  Charters  of  the  latter  kind  are  known 
as  special  charters  and  are  rarely  used  nowa- 
days, except  in  the  case  of  institutions  of  a 
peculiar  character,  endowed  with  special  func- 
tions. The  central  banks  of  Europe  owe  their 
existence  to  such  charters,  as  did  also  the  first 
and  second  United  States  banks.  In  the  early 
history  of  the  United  States  special  charters 
were  uniformly  employed  by  the  states,  but 
for  many  years  general  incorporation  laws 
have  been  the  rule,  on  compliance  with  the 
requirements  of  which  persons  who  desire  to 
incorporate  banks  can  secure  charters. 

In  federal  states,  both  the  federal  govern- 
ment and  the  governments  of  the  constituent 
states  frequently  have  and  exercise  the  right 
to  incorporate  banks.  In  the  United  States, 
banks  incorporated  by  the  federal  government 
under  the  terms  of  a  general  law,  originally 
passed  in  1863  and  many  times  amended  since 
that  date,  are  known  as  national  banks,  and 
those    incorporated    by    the    states    under   the 


Banking  Institutions 


terms  of  general  banking  acts  or  of  general 
incorporation  laws  are  known  as  state  banks. 
These  latter  are  endowed  with  privileges  which 
enable  them  to  exercise  commercial  and  some 
investment  banking  functions.  Other  banks 
also  are  incorporated  by  our  states  under  the 
terms  of  general  laws,  which  are  known  as  sav- 
ings banks  and  trust  companies.  The  former, 
as  the  name  implies,  are  institutions  primarily 
designed  for  the  encouragement,  collection,  and 
investment  of  savings.  The  latter  are  called 
trust  companies  because  the  earliest  institutions 
of  this  type  made  the  execution  of  trusts  of 
various  kinds  their  exclusive  business.  Bank- 
ing functions  were  later  added  and  in  many 
cases  have  now  assumed  chief  importance. 

The  nature  of  the  banking  business  requires 
some  kind  of  organization  of  the  individual 
institutions  in  which  certain  ones  will  assume 
to  a  degree  at  least  the  role  of  bankers'  banks. 
In  most  European  countries  this  position  is 
occupied  by  single  institutions  specially  char- 
tered and  endowed  with  special  privileges  and 
usually  described  as  central  banks.  Examples 
are  the  Bank  of  England  in  England,  the  Bank 
of  France  in  France,  and  the  Imperial  Bank 
of  Germany  in  Germany.  Around  these  are 
grouped  the  other  institutions   in   a  kind  of 


io  Banking 

hierarchy,  certain  large  banks  in  the  larger 
cities  forming  centers  about  which  smaller  in- 
stitutions group  themselves.  In  the  United 
States  there  is  no  single  central  institution, 
but  a  small  group  of  banks  in  New  York  City 
are  the  real  centers  of  the  system.  Around 
these  are  grouped  the  banks  in  the  other  large 
cities  of  the  country  and  these  in  turn  perform 
important  services  for  banks  in  the  surround- 
ing smaller  towns  and  country  districts. 


CHAPTER  II 

The  Nature  and  Operations  of  Commer- 
cial Banking 

TN  the  preceding  chapter  commercial  bank- 
■*•  ing  has  been  defined  as  the  conduct  of  ex- 
changes by  means  of  a  world-wide  process  of 
bookkeeping.  We  must  now  describe  this 
process.  Its  essential  features  are  the  discount 
of  commercial  paper,  the  conduct  of  checking 
accounts,  and  the  issue  of  notes. 

i.  Commercial  Paper 

By  commercial  paper  is  meant  the  credit 
instruments  or  documents  which  the  credit  sys- 
tem now  in  general  use  throughout  the  com- 
mercial world  regularly  brings  into  existence 
and  liquidates. 

The  essence  of  this  system  is  buying  and  sell- 
ing on  time.  The  farmer  buys  seed,  imple- 
ments, fertilizer,  labor,  etc.,  and  pays  for  them 
after  the  crops  have  been  harvested  and  sold. 
The  manufacturer  buys  raw  materials  and  pays 
ii 


12  Banking 

for  them  after  they  have  passed  through  the 
transformation  process  which  he  conducts  and 
the  completed  goods  have  been  marketed.  He 
frequently  sells  them  to  jobbers  or  wholesalers 
on  time  and  these  in  turn  sell  them  on  time  to 
retailers  and  these  to  consumers.  Farmers, 
manufacturers,  and  merchants  both  buy  on  time 
and  sell  on  time,  and  are  thus  both  debtors  and 
creditors,  and  each  expects  that  his  sales  will 
ultimately  pay  for  his  purchases. 

The  obligations  involved  in  these  transac- 
tions are  represented  and  recorded  in  the  form 
of  book  accounts,  promissory  notes,  or  bills 
of  exchange,  the  latter  being  written  or  printed, 
or  partly  written  and  partly  printed,  orders  of 
creditors  on  debtors  to  pay  to  themselves  or 
to  third  parties  the  sums  indicated.  These 
documents  are  being  constantly  made  and  con- 
stantly paid  as  the  processes  of  agriculture,  in- 
dustry, and  commerce  proceed.  Indeed,  their 
creation  and  liquidation  is  a  normal  phenome- 
non of  our  modern  economic  life. 

The  term  commercial  paper,  as  we  are  using 
it,  applies  to  such  promissory  notes  and  bills 
of  exchange  as  belong  to  this  credit  system. 
It  does  not  apply  to  such  notes  and  bills  when 
they  owe  their  existence  to  credit  operations  of 
a  different  kind,  such  for  example  as  accom- 


Nature  of  Commercial  Banking         13 

modation  loans  or  investment  operations. 
Indeed,  the  essential  characteristic  of  commer- 
cial paper  is  not  revealed  in  the  form  of  the 
credit  document  but  in  the  fact  that  it  is  a  link 
in  this  chain  of  exchange  operations  by  which 
modern  commerce  is  carried  on. 

This  use  of  the  term  should  also  be  distin- 
guished from  the  one  common  among  bankers 
and  others.  In  this  popular  usage  these  docu- 
ments are  called  commercial  paper  because  they 
are  themselves  objects  of  commerce.  In  our 
use  of  the  term  the  adjective  "commercial" 
applies  to  them  only  when  they  play  the  role  of 
intermediary  in  a  process  of  exchange  through 
credit.  In  this  sense  it  is  a  matter  of  indiffer- 
ence whether  they  pass  through  the  hands  of 
brokers  or  not,  and  the  fact  of  their  being 
objects  of  purchase  and  sale  does  not  confer 
the  quality  of  commercial  paper  upon  docu- 
ments having  an  origin  and  character  other 
than  that  above  described. 

2.  The  Operation  of  Discount 

Every  person  in  this  chain  of  credit  is  con- 
fronted with  the  problem  of  paying  his  debts 
as  they  mature  by  the  use  of  the  amounts  due 
him    from   other   people.      Since   it   is   rarely 


14  Banking 

possible  to  arrange  maturities  on  both  sides 
in  such  a  way  that  the  amounts  due  to  be  paid 
him  at  a  given  date  shall  at  least  equal  those 
he  is  due  to  pay  on  that  date,  some  means  of 
transforming  claims  against  other  people  due 
in  the  future  into  present  means  of  payment 
must  be  found.  The  one  universally  employed 
is  the  discount  of  commercial  paper.  By  this 
is  meant  the  exchange  at  a  bank  of  his  own 
promissory  notes  due  at  times  when  debts  of 
equal  or  greater  amount  due  him  mature,  or 
of  bills  of  exchange  drawn  against  his  debtors, 
for  cash  or  credits  on  a  checking  account. 
These  latter  are  available  as  means  of  payment 
at  any  time. 

As  a  consideration  for  this  accommodation, 
the  bank  charges  interest  for  the  period  inter- 
vening before  the  maturity  of  the  paper  dis- 
counted. Sometimes  this  charge  is  paid  at  the 
time  the  paper  is  purchased  and  sometimes  at 
the  date  of  its  maturity.  The  term  "  discount  " 
technically  means  taking  interest  in  advance  by 
making  available  as  means  of  present  payment 
in  any  of  the  above  mentioned  forms  a  sum 
less  than  the  amount  the  bank  expects  to  collect 
at  the  date  of  the  maturity  of  the  discounted 
paper.  If  the  interest  is  paid  when  the  dis- 
counted  paper  matures,   the   process  is   tech- 


Nature  of  Commercial  Banking         15 

nically  called  a  loan.  However,  since  the  time 
of  collecting  interest  makes  no  essential  differ- 
ence in  the  nature  of  the  transaction,  the 
process  is  commonly  described  as  the  discount 
of  commercial  paper,  regardless  of  whether  the 
interest  is  collected  in  advance  or  not. 

5.  The  Conduct  of  Checking  Accounts 

A  checking  account  is  an  ordinary  book 
account  on  which  are  credited  the  cash  depos- 
ited by  a  customer  and  the  proceeds  of  collec- 
tions, loans,  and  discounts  made  on  his  behalf, 
and  on  which  are  debited  payments  made  to 
him  in  cash  or  on  his  behalf  to  other  people  or 
to  the  bank  itself.  These  payments  are  made 
on  orders  signed  by  the  customer  and  known 
as  checks. 

The  ordinary  customer  of  a  commercial  bank 
every  day  brings  to  the  bank  the  cash  he 
receives  as  the  result  of  the  day's  business,  and 
the  checks  received,  drawn  on  his  own  and 
other  banks,  and  is  credited  with  the  amount  on 
the  books  of  the  bank  as  well  as  on  a  passbook 
which  he  himself  retains.  If  he  needs  cash 
during  the  day,  he  presents  to  the  bank  a  check 
payable  to  himself  for  the  amount  needed,  and 
receives  the  kinds  and  denominations  wanted; 


1 6  Banking 

and  if  he  wants  to  make  payments  to  his  cred- 
itors in  other  forms  than  cash,  he  sends  them 
checks  on  his  bank  payable  to  their  order,  or  a 
check  drawn  by  his  bank  on  some  bank  in 
another  place,  usually  called  a  draft,  which  he 
has  obtained  by  exchanging  for  it  a  check 
drawn  to  the  order  of  his  bank.  To  the 
amount  of  these  payments  his  account  at  the 
bank  is  debited,  and  from  time  to  time  his  pass- 
book is  left  at  the  bank  for  the  entry  therein 
of  the  debits  made  to  date  and  its  subsequent 
return  to  him. 

The  customer  must  take  care  that  his 
account  is  not  overdrawn,  that  is,  that  the 
debits  on  his  account  do  not  exceed  the  credits, 
since  overdrafts,  except  by  accident  or  for 
very  short  periods  and  small  amounts,  are  not 
allowed  in  this  country,  and  in  other  countries, 
where  they  are  allowed,  they  must  be  provided 
for  in  advance  by  a  special  agreement  between 
the  bank  and  the  customer,  which  usually 
involves  the  deposit  with  the  bank  of  ample 
security.  In  order  to  avoid  overdrafts,  the  cus- 
tomer in  this  country  agrees  with  his  banker 
on  what  is  known  as  a  "  line,"  that  is,  a  maxi- 
mum amount  of  loans  or  discounts  to  be 
allowed.  Whenever  his  credit  balance  falls 
to   a    certain    minimum,    also    established    by 


Nature  of  Commercial  Banking         ij 

agreement  with  the  bank,  the  latter  discounts 
for  him  the  paper  of  his  customers,  that  is, 
bills  of  exchange  drawn  on  them  or  their 
promissory  notes  in  his  favor,  or  his  own 
promissory  notes.  The  proceeds  of  these  dis- 
counts are  credited  on  his  account  like  deposits 
of  cash  or  of  checks  for  collection. 

So  long  as  the  discounts  are  confined  to  com- 
mercial paper  the  bank's  part  in  these  transac- 
tions consists  almost  exclusively  of  bookkeep- 
ing between  its  customers  and  between  itself 
and  other' banks.  Ordinarily,  what  is  debited 
on  one  man's  account  is  credited  on  another's, 
the  cash  received  nearly  balancing  that  paid 
out.  To  the  extent  that  the  cash  receipts  and 
payments  do  not  balance,  the  bank  either  has  a 
surplus  or  is  obliged  to  provide  for  the  meeting 
of  a  deficit.  The  means  available  for  this  latter 
purpose  will  be  explained  in  subsequent  sec- 
tions, as  well  as  some  of  the  details  of  this 
bookkeeping  process.  For  the  present  it  is  im- 
portant to  note  precisely  how  the  discount  of 
commercial  paper  is  related  to  this  bookkeeping 
process. 

As  explained  in  Section  i,  commercial  paper 
is  an  essential  part  of  the  process  of  exchang- 
ing goods  through  credit.  A  person  buys  on 
time  and  sells  on  time  and  expects  to  pay  for 


1 8  Banking 

his  purchases  by  the  proceeds  of  his  sales.  So 
long,  therefore,  as  the  processes  of  commerce 
and  industry  proceed  in  a  normal  fashion,  the 
paper  discounted  by  a  bank  will  be  paid  at 
maturity  and  the  credit  balance  created  by 
means  of  such  discounts  offset  by  correspond- 
ing debits.  Ordinarily  the  credits  created 
through  discounts  during  a  given  period,  say 
a  day  or  a  week,  in  favor  of  one  set  of  cus- 
tomers will  be  balanced  during  this  same  period 
by  the  payment  of  notes  previously  discounted 
for  other  customers.  Within  a  complete  trad- 
ing area  this  is  certain  to  happen,  since  pur- 
chases and  sales  of  goods  are  equal  and  what 
is  credited  to  one  man  is  debited  to  another. 
The  result  is  very  different  if  a  bank  discounts 
investment  paper,  that  is,  credit  documents 
which  represent  the  unproductive  consump- 
tion of  individuals  or  of  public  and  private 
corporations,  or  which  represent  the  purchase 
on  time  of  the  instruments  of  production  rather 
than  the  production  of  goods  through  the  use 
of  such  instruments  and  their  transfer  from 
the  producer  to  the  consumer.  The  means  of 
payment  of  such  documents  can  only  be  created 
gradually  by  the  application  of  the  profits  of 
the  enterprises  in  which  the  investments  were 
made,  or  by  taxes  spread  over  a  series  of  years, 


Nature  of  Commercial  Banking         19 

or  by  a  slow  process  of  saving.  If  a  bank 
issues  its  own  demand  obligations  in  exchange 
for  such  documents,  it  cannot  make  its  books 
balance  and  it  will  be  constantly  exposed  to 
the  danger  of  forced  liquidation.  If  it  attempts 
to  protect  itself  by  requiring  that  the  discounted 
paper  shall  mature  in  a  short  period,  the  neces- 
sity of  liquidation  will  be  forced  upon  customers 
who  are  responsible  for  the  payment  of  the 
discounted  paper;  that  is,  such  customers  will 
be  obliged  to  sell  at  such  prices  as  they  can 
command  the  property  in  which  the  investments 
were  made,  or  some  other  property.  Such 
liquidation  always  results  in  forced  readjust- 
ments of  prices  and  business  depression,  and 
sometimes  in  commercial  crises. 

4.  The  Issue  of  Notes 

As  an  alternative  for  or  a  supplement  to  the 
conduct  of  checking  accounts  a  commercial 
bank  may  issue  its  promissory  notes  payable  to 
bearer  on  demand.  By  the  issue  of  notes  is 
meant  their  transfer  to  customers  in  exchange 
for  cash,  for  checks  left  for  collection  or  drawn 
against  a  credit  balance  in  a  checking  account, 
or  for  discounted  notes  and  bills. 

By  the  use  of  these  notes  commercial  bank- 


20  Banking 

ing  can  be  carried  on  without  checking 
accounts.  In  that  case  the  notes  are  issued  in 
exchange  for  cash  and  discounted  bills,  and 
notes  are  returned  to  the  bank  in  exchange  for 
cash  or  when  discounted  bills  or  notes  mature 
and  are  paid.  In  the  bookkeeping  process 
which  has  been  described  bank  notes  thus 
issued  and  returned  perform  precisely  the  same 
function  as  checking  accounts,  and  are  related 
to  the  discount  of  commercial  paper  and  the 
credit  system  of  the  country  in  precisely  the 
same  manner  as  such  accounts. 

Most  banks  of  issue  at  the  present  time  con- 
duct checking  accounts  also,  using  the  one 
instrumentality  or  the  other  as  their  customers 
desire.  In  this  case  notes  are  issued  in  ex- 
change for  checks  drawn  against  credit  bal- 
ances on  checking  accounts  or  deposited  for 
collection  as  well  as  in  exchange  for  dis- 
counted notes  and  bills  and  cash. 

By  the  use  of  both  notes  and  checking  ac- 
counts, a  bank  can  supply  most  of  the  needs 
of  its  customers  for  a  circulating  medium,  the 
notes  serving  as  hand-to-hand  money,  and  the 
checking  accounts,  practically  all  other  pur- 
poses. Being  the  direct  obligations  of  banks 
attested  by  the  signatures  of  their  responsible 
officers,  and  being  payable  to  bearer  on  demand 


Nature  of  Commercial  Banking         21 

and  capable  of  being  issued  in  all  necessary 
denominations,  such  notes  can  be  transferred 
without  indorsement,  can  be  used  for  making 
change  and  payments  of  small  and  moderate 
size  for  which  checks  are  not  convenient,  and 
they  do  not  need  to  be  presented  at  a  bank  for 
the  test  of  their  validity.  If  the  bank  or  banks 
which  issue  them  are  properly  conducted  and 
supervised  and  properly  safeguarded  by  law, 
such  notes  will  circulate  freely  through  the 
length  and  breadth  of  a  country. 

Checking  accounts  meet  in  the  most  satis- 
factory manner  all  currency  needs  for  which 
hand-to-hand  money  is  not  well  adapted,  such 
as  large  payments  and  payments  at  a  distance. 
With  a  few  strokes  of  a  pen  payments  of  the 
greatest  magnitude  can  be  made  through  their 
agency.  Checks  can  be  sent  through  the  mails 
at  slight  expense  and  without  danger  of  loss 
of  the  amount  involved.  By  the  devices  known 
as  travelers'  and  commercial  letters  of  credit, 
checking  accounts  supply  the  most  convenient 
form  of  currency  for  travelers  and  for  mer- 
chants engaged  in   foreign  trade. 

Besides  bank  notes  and  checking  accounts 
the  only  forms  of  currency  needed  in  any  com- 
munity are  standard  and  subsidiary  coins,  the 
former  for  use  as  ultimate  redemption  material 


22  Banking 

for  all  other  forms  of  currency  and  for  the 
payment  of  international  and  other  balances, 
and  the  latter  for  small  change.  Even  these 
forms  of  currency  are  supplied  by  commercial 
banks,  but  since  they  do  not  create  them,  ways 
and  means  of  procuring  them  in  the  quan- 
tities needed  constitute  one  of  their  peculiar 
problems. 

5.  Collections 

One  of  the  most  important  functions  of  com- 
mercial banks  is  the  collection  for  their  cus- 
tomers of  checks  and  drafts  drawn  on  other 
institutions.  When  these  documents  are  re- 
ceived, the  accounts  of  customers  who  depos- 
ited them  are  credited  with  the  amounts,  less 
a  small  fee  for  collection,  unless  by  agreement 
this  service  of  collection  is  performed  free  of 
charge.  The  checks  are  then  assorted  accord- 
ing to  the  banks  upon  which  they  are  drawn 
and  the  cities  in  which  those  banks  are  located. 

Checks  drawn  upon  home  banks  are  collected 
either  through  messengers  who  present  the 
checks  at  the  counters  of  the  banks  upon  which 
they  are  drawn  and  secure  payment  therefor, 
or  through  the  local  clearing  house.  This  is  a 
place  where  representatives  of  the  banks  meet 
for  the  exchange  of  checks.     After  the  repre- 


Nature  of  Commercial  Banking         23 

sentative  of  each  bank  has  distributed  all  the 
checks  held  by  his  institution  against  the 
others  participating  in  the  clearing,  and  re- 
ceived from  them  those  drawn  against  his 
bank,  a  balance  sheet  is  prepared  showing  the 
balance  due  by  or  to  his  bank  after  the  total 
of  the  checks  distributed  has  been  balanced 
against  the  total  received.  If  said  balance  is 
adverse,  it  is  paid  to  the  master  of  the  clear- 
ing house,  and  if  it  is  favorable,  it  is  received 
from  him. 

The  checks  received  through  the  clearing 
house  or  presented  by  messengers  from  other 
banks  and  paid,  are  debited  to  the  accounts  of 
the  persons  who  drew  them  and  returned  to 
such  persons  as  vouchers,  the  net  result  of  the 
entire  transaction  being  the  same  as  if  all  the 
parties  involved  had  been  customers  of  a  single 
bank,  with  the  exception  that  some  means  of 
paying  balances  had  to  be  found.  Since  bal- 
ances are  sometimes  paid  by  checks  on  some 
central  institution  in  which  credit  balances 
may  be  obtained  by  rediscounts  of  commercial 
paper,  this  necessity  can  be  met  without  the 
use  of  any  form  of  currency  other  than  that 
furnished  by  banks  themselves. 

Checks  drawn  upon  out-of-town  banks  are, 
in  this  country,  collected  through  so-called  cor- 


24  Banking 

respondents.  Each  bank  enters  into  an  arrange- 
ment with  a  few  other  banks,  distributed 
throughout  the  country  and  conveniently 
located  for  the  purpose,  by  which  the  corre- 
spondent bank  agrees  to  conduct  with  it  a 
checking  account  on  which  it  will  credit  at  par 
or  at  a  stipulated  discount  the  checks  sent  it  for 
collection  and  debit  checks  drawn  against  such 
an  account.  A  comparatively  small  number  of 
such  correspondents  suffices,  since  certain  banks 
in  the  larger  cities,  by  making  a  business  of 
such  collections,  conduct  checking  accounts 
with  a  large  number  of  banks,  and  can  thus 
make  collections  by  mere  transfers  of  credits 
on  their  own  books  or  by  the  use  of  the  local 
clearing  house.  The  so-called  reserve  cities  in 
this  country  constitute  clearing  centers  for  the 
territories  contiguous  to  them,  and  New  York, 
Chicago,  and  St.  Louis,  for  the  entire  country. 

Checks  received  from  correspondents  and 
drawn  against  themselves  are  debited  to  the 
accounts  of  the  customers  who  drew  them  and 
returned  as  vouchers  in  the  same  manner  as 
checks  received  through  the  clearing  house  or 
paid  over  their  own  counters. 

Through  this  interchange  of  checks  between 
banks  and  the  conduct  of  checking  accounts 
with    each    other,    intermunicipal    and    inter- 


Nature  of  Commercial  Banking         25 

national  exchanges  are  conducted  through  the 
bookkeeping  processes  of  commercial  banks 
with  the  same  ease  and  economy  as  are  ex- 
changes between  people  living  in  the  same 
town. 

6.  Domestic  Exchange 

The  accounts  of  a  bank  with  its  correspond- 
ents are  a  record  of  the  transactions  of  its  cus- 
tomers with  the  outside  world,  the  checks  they 
receive  as  a  result  of  sales  to  outsiders  of 
merchandise,  real  estate  or  other  property,  or 
as  a  result  of  gifts  by  outsiders  to  them  being 
credited  on  such  accounts,  while  the  checks 
they  draw  or  the  drafts  they  purchase  in  pay- 
ment for  merchandise,  real  estate  or  other 
property  purchased  of  outsiders,  or  of  gifts 
made  to  them  are  debited.  When  in  a  given 
period,  say  a  day  or  a  week,  the  receipts  of  the 
customers  of  a  bank  from  outsiders,  as  a  result 
of  current  or  past  sales  and  gifts,  exceed  the 
payments  made  by  them  as  a  result  of  pur- 
chases and  gifts,  its  credit  balances  with  its  cor- 
respondents will  increase,  and  under  opposite 
conditions  they  will  decrease.  If  the  payments 
should  continue  in  excess  for  a  considerable 
period,  the  credit  balances  of  a  bank  with  its 
correspondents  would  be  exhausted  and  some 


26  Banking 

means  of  replenishing  them  would  have  to  be 
found,  and  under  the  opposite  conditions  too 
large  a  portion  of  the  bank's  resources  would 
accumulate  with  its  correspondents  and  some 
means  of  withdrawing  funds  would  have  to  be 
found. 

When  a  bank  needs  to  replenish  its  credit 
balances  with  its  correspondents,  it  may  ship 
cash  or  purchase  drafts  from  other  home  banks, 
which  it  can  send  to  its  correspondents  for 
collection  like  checks  deposited  in  the  ordinary 
course  of  business.  The  latter  resource  will 
of  course  be  available  only  when  these  other 
banks'  balances  with  their  correspondents  are 
not  exhausted.  Should  the  balances  of  all  the 
banks  of  a  town  with  their  out-of-town  corre- 
spondents be  nearly  or  quite  exhausted,  ship- 
ments of  cash  to  correspondents  could  not  be 
avoided.  If  a  bank  wishes  to  withdraw  funds 
from  its  correspondents  for  home  use,  it  may 
order  cash  shipped  or  it  may,  perhaps,  be  able 
to  sell  drafts  for  cash  to  other  home  banks. 

The  expenses  involved  in  shipments  of  cash, 
loans,  or  purchases  or  sales  of  drafts  for  the 
purpose  of  replenishing  balances  with  or  with- 
drawing them  from  out-of-town  correspond- 
ents, give  rise  to  what  is  called  the  rate  of 
exchange.     If,  in  order  to  make  out-of-town 


Nature  of  Commercial  Banking  27 

payments  for  its  customers,  a  bank  is  obliged 
to  pay  the  expense  of  shipping  cash  to  its  corre- 
spondents or  to  pay  a  premium  on  drafts  pur- 
chased from  other  banks,  the  natural  method 
of  reimbursement  will  be  a  premium  charge  on 
drafts  sold  equal  to  the  amount  of  the  expense 
incurred.  If  it  wishes  to  withdraw  a  balance 
with  its  correspondent,  since  to  order  cash 
shipped  will  involve  expense,  it  will  be  glad 
to  sell  drafts  for  cash  at  a  discount  not  to 
exceed  such  expense. 

The  rate  of  exchange,  or  the  price  of  drafts 
on  a  given  point,  may,  therefore,  fluctuate  be- 
tween a  premium  equal  to  the  cost  of  shipping 
cash  to  that  point  and  a  discount  of  the  same 
amount.  Beyond  these  extremes,  these  fluctua- 
tions cannot  ordinarily  go,  because  customers 
may  demand  cash  of  their  banks  in  payment 
of  checks  against  their  own  credit  balances  and 
ship  it  to  their  out-of-town  creditors  at  their 
own  expense,  and  would  do  so  if  the  rates 
charged  on  drafts  should  make  such  procedure 
profitable.  The  actual  rate  of  exchange  will 
not  ordinarily  reach  either  of  these  extremes, 
on  account  of  competition  either  between  the 
banks  which  are  desirous  of  selling  drafts  on 
their  correspondents  or  between  those  which 
are  forced  to  buy  as  an  alternative  to  cash  ship- 


28  Banking 

ments.  If  the  aggregate  balances  of  the  banks 
of  a  town  with  their  out-of-town  correspond- 
ents are  large  and  increasing,  the  pressure  to 
sell  drafts  will  be  greater  than  that  to  buy  and 
the  rate  of  exchange  will  go  to  a  discount,  the 
amount  of  which,  however,  will  be  fixed  by 
competition  between  the  selling  banks.  In  the 
opposite  case,  the  rate  will  go  to  a  premium 
and  be  fixed  by  competition  between  the  buy- 
ing banks. 

In  most  towns  in  the  United  States  there  is 
little  or  no  competition  between  banks  in  the 
business  of  buying  and  selling  drafts  and  con- 
sequently no  open  market  for  exchange  and  no 
quotations  of  exchange  rates.  In  such  cases 
each  bank  acts  more  or  less  independently ;  ship- 
ments of  cash  to  or  from  correspondents  are 
the  ordinary  means  of  regulating  balances ;  and 
the  cost  of  such  shipments  are  charged  to  the 
general  expense  account  of  the  bank  and  taken 
out  of  customers  either  by  a  fixed  and  more  or 
less  invariable  charge  on  drafts  sold,  or  in 
other  ways. 

Since  the  balances  of  the  banks  of  a  town 
with  their  out-of-town  correspondents  depend 
primarily  upon  the  commercial  and  gift  rela- 
tions of  their  customers  with  the  outside  world, 
it  is  pertinent  to  inquire  whether  as  a  result  of 


Nature  of  Commercial  Banking  29 

a  long  continued  excess  of  purchases  from  out- 
siders over  sales  to  them  and  of  gifts  to  over 
gifts  from  them,  the  cash  resources  of  a  com- 
munity might  not  be  completely  exhausted, 
and  if  not,  how  such  an  outcome  is  prevented. 

Bankers  have  no  direct  control  over  the  pur- 
chases and  sales  of  their  customers,  but 
through  the  rate  of  interest  they  charge  on 
loans  and  discounts  and  their  ability  absolutely 
to  discontinue  such  accommodations  they  exert 
a  very  potent  indirect  influence.  The  rates  of 
interest  and  discount  charged  are  an  important 
element  in  the  cost  of  doing  business  and,  if 
loaning  and  discounting  is  discontinued,  sales 
of  property  to  meet  maturing  obligations  are 
forced,  with  the  result  of  price  readjustments 
between  the  town  in  question  and  the  out- 
side world  which  speedily  change  the  relations 
between  purchases  and  sales. 

When  the  cash  resources  of  the  banks  of  a 
town  approach  the  limit  of  safety  and  their 
balances  with  their  correspondents  fall  to  an 
ominously  low  point,  the  normal  method  of 
procedure  is  to  raise  the  rates  on  loans  and 
discounts,  and  if  conditions  grow  worse,  to 
raise  them  higher  still  and  as  a  last  resort  to 
cease  temporarily  to  make  them  at  any  price. 
By  increasing  the  cost  of  doing  business  this 


30  Banking 

rise  in  the  rates  will  check  purchases  by  dimin- 
ishing or  annihilating  the  profits  resulting,  and 
will  stimulate  sales  by  rendering  it  more  profit- 
able for  some  customers  to  secure  funds  by 
sales  to  outsiders  at  lower  prices  than  were  for- 
merly asked  rather  than  by  borrowing  from 
banks.  Under  ordinary  circumstances  this 
procedure  will  be  sufficient  to  change  an  unfa- 
vorable into  a  favorable  balance  of  indebted- 
ness with  the  outside  world,  with  the  result 
that  more  checks  on  outside  institutions  will 
be  deposited  with  the  banks  and  a  smaller 
amount  of  drafts  purchased.  Bankers'  balances 
with  their  correspondents  will,  therefore,  in- 
crease, and  with  them  their  ability  to  command 
cash  in  case  of  need.  The  demands  made  upon 
them  for  cash  will  also  decrease,  since  the  vol- 
ume of  loans  and  of  business  transacted  will 
fall. 

If  the  banks  stop  discounting,  a  more  or 
less  violent  readjustment  with  the  outside 
world  results.  Business  men  who  have  obliga- 
tions to  meet,  and  most  of  them  will  belong  to 
this  class,  are  obliged  to  sell  their  goods  and 
property  at  whatever  prices  are  necessary  and 
to  stop  purchasing  entirely.  The  outcome,  so 
far  as  the  banks  are  concerned,  is  as  above 
indicated.     If  conditions  are  such  that  sales 


Nature  of  Commercial  Banking  31 

at  any  price  cannot  be  forced,  a  crisis  ensues; 
that  is,  business  operations  are  temporarily  sus- 
pended and  transfers  of  property  in  settlement 
of  obligations  are  made  through  bankruptcy 
and  other  court  proceedings. 

7.  Foreign  Exchange 

The  business  relations  between  banks  located 
in  different  countries  do  not  differ  in  any  essen- 
tial respect  from  those  between  banks  located  in 
the  same  country.  Interchange  of  checks,  the 
conduct  of  checking  accounts,  shipments  of 
cash,  and  borrowing  and  lending  proceed  in  the 
same  manner  as  between  domestic  institutions. 
The  chief  peculiarities  of  the  foreign  exchanges 
are  due  to  the  fact  that  different  units  of  value 
and  sometimes  different  standards  must  here  be 
reckoned  with,  and  that  the  precious  metals, 
chiefly  gold,  are  used  in  the  settlement  of  bal- 
ances. Drafts  drawn  in  the  United  States  on 
English  points,  for  example,  call  for  the  pay- 
ment of  pounds  sterling,  those  on  French 
points  for  francs,  and  those  on  German  points 
for  marks,  while  all  must  be  paid  for  in  dollars. 

The  translation  of  the  language  of  values  of 
one  country  into  that  of  others  thus  involved 
requires  the  calculation  of  a  so-called  par  of 


32  Banking 

exchange.  By  this  is  meant  the  relation  be- 
tween the  weights  of  pure  metal  contained  in 
their  respective  units  of  value,  if  the  countries 
in  question  have  the  same  standard,  and  the 
relation  between  the  market  values  of  the 
metallic  content  of  their  units,  if  their  stand- 
ards are  different.  Thus  the  par  of  exchange 
between  this  country  and  England  is  $4.8665, 
since  our  dollar  contains  23.22  grains  of  pure 
gold  and  the  English  pound  sterling  4.8665 
times  as  many  grains,  or  1 13.0016.  Our  par 
of  exchange  with  France  is  19.294  cents,  the 
quotient  of  4.4802,  the  number  of  grains  of 
pure  gold  in  the  French  franc,  divided  by  23.22. 
Between  China  and  the  United  States  the  par 
of  exchange  is  the  market  value  in  our  dollars 
of  the  amount  of  silver  contained  in  the  tael, 
the  Chinese  unit. 

Another  technical  term  employed  in  connec- 
tion with  the  foreign  exchanges  is  the  gold 
points.  These  are  the  points  above  and  below 
the  par  of  exchange  fixed  by  the  addition  in  the 
one  case,  and  the  subtraction  in  the  other,  of 
the  cost  of  shipping  gold  between  the  two  places 
in  question.  They  are  the  points  between 
which  the  rates  of  exchange  fluctuate,  or  the 
points  at  which,  when  the  rate  of  exchange 
reaches  them,  gold  moves  between  gold  stand- 


Nature  of  Commercial  Banking        33 

ard  countries.  Assuming  for  example,  that  the 
cost  of  shipping  gold  between  New  York  and 
London  is  two  cents  per  pound  sterling,  the 
gold  points  arc  4.8865  and  4.8465,  it  being 
profitable  to  ship  gold  from  New  York  to  Lon- 
don when  sterling  exchange  reaches  the  former 
figure  and  to  import  gold  from  London  when 
it  reaches  the  latter  figure. 

In  the  conduct  of  the  foreign  exchanges  sev- 
eral classes  of  bills  are  employed  upon  which 
the  quotations  differ,  in  part  on  account  of  dif- 
ferences in  their  quality  and  in  part  on  account 
of  the  interest  element  entering  into  the  value 
of  time  bills.  For  example,  New  York  regu- 
larly quotes  on  London  cables,  demand,  and 
sixty-day  bills.  The  rates  on  a  certain  date 
were:  Cables,  4.8860;  demand,  4.8790;  and 
sixty  days,  4.8370.  Inasmuch  as  these  are  all 
bankers'  bills  and  consequently  of  the  same 
quality,  the  differences  in  their  quotations  are 
due  to  the  interest  element  and  to  the  fact  that 
in  the  case  of  the  cables  the  cost  of  the  cable- 
gram is  included. 

When  a  New  York  banker  sells  a  cable  on 
London,  his  balance  with  his  correspondent  is 
reduced  by  the  amount  in  a  few  hours,  and 
the  interest  he  receives  on  such  balances  is  pro- 
portionately diminished  at  once,  and  he  is  also 


34  Banking 

out  the  cost  of  the  necessary  cablegram.  When 
he  sells  a  demand  bill,  his  account  with  his 
London  correspondent  remains  undiminished 
during  the  time  required  for  sending  the  bill 
by  mail  across  the  Atlantic  and  for  its  presen- 
tation for  payment.  He  draws  interest  on  his 
entire  balance  during  this  period.  When  he 
sells  a  sixty-day  bill,  his  balance  does  not  suffer 
diminution  on  its  account  for  sixty  days.  In 
order  to  place  these  bills  on  a  footing  of  equal- 
ity so  far  as  he  is  concerned,  therefore,  he  must 
quote  demand  and  sixty-day  bills  lower  than 
cables;  the  former  by  the  cost  of  the  cable- 
gram plus  interest  on  the  amount  of  the  bill, 
say  for  ten  days,  at  the  rate  he  receives  on  his 
London  balance,  and  the  latter  by  the  amount 
of  the  cablegram  plus  interest  on  the  amount 
for  sixty  days  at  the  same  rate. 

Trade,  or  mercantile,  as  well  as  bankers'  bills 
are  also  frequently  and,  in  some  markets,  regu- 
larly quoted.  Being  of  a  quality  ranked  as 
inferior  to  bankers'  bills,  they  must  be  nego- 
tiated at  a  lower  rate  and  are  quoted  accordingly. 


CHAPTER  III 

The  Problems  of  Commercial  Banking 

'  I  ^HE  conduct  of  commercial  banking  pre- 
■*■  sents  problems  both  to  the  bankers  and 
to  the  public,  the  methods  of  solution  of 
which  will  be  given  attention  at  this  point. 
The  problems  concerning  the  bankers  primarily 
may  be  grouped  under  the  heads,  supply  of 
cash,  selection  of  loans  and  discounts,  and 
rates;  and  those  which  primarily  concern  the 
public  may  be  grouped  under  the  heads,  protec- 
tion against  unsound  practices,  and  adequacy 
and  economy  of  service. 

i.  The  Supply  of  Cash 

The  credit  balances  on  checking  accounts  and 
the  notes  of  commercial  banks  are  payable  on 
demand  in  the  legal-tender  money  of  the  nation 
to  which  they  belong,  and  such  banks  must  at 
all  times  be  prepared  to  meet  these  obligations. 

The  term  employed  to  designate  the  funds 
provided  for  this  purpose  is  reserves,  and  in  this 

35 


36  Banking 

country  they  consist  of  money  kept  on  hand 
and  of  credit  balances  in  other  banks.  In  other 
countries  there  is  also  included  under  this  head 
commercial  bills  of  the  kind  which  can  always 
be  discounted.  The  term  secondary  reserve  is 
sometimes  employed  in  this  country  to  desig- 
nate certain  securities,  such  as  high-class  bonds 
listed  on  the  stock  exchanges,  which  can  be 
sold  readily  for  cash  in  case  of  need. 

The  amount  of  reserve  required  can  be  deter- 
mined only  by  experience.  In  ordinary  times 
it  depends  chiefly  upon  the  habits  of  the  com- 
munity in  which  the  bank  is  located  regarding 
the  use  of  hand-to-hand  money  as  distinguished 
from  checks  and  upon  the  character  of  its  cus- 
tomers. These  habits  differ  widely  in  differ- 
ent nations,  and  considerably  in  the  different 
sections  and  classes  of  the  same  nation.  In 
most  European  and  Oriental  countries,  for 
example,  checks  are  little  used  by  the  masses 
of  the  people,  while  in  the  United  States  and 
England  they  are  widely  used.  In  these  latter 
countries,  however,  they  are  less  widely  used 
by  people  in  the  country  than  in  the  cities,  and 
by  the  laboring  than  the  other  classes  in  the 
cities.  Within  the  same  city  one  bank  may 
need  to  keep  larger  reserves  than  another  on 
account  of  the  peculiarities  of  the  lines  of  busi- 


Problems  of  Commercial  Banking       37 

ness  carried  on  by  its  customers  and  the  classes 
of  people  with  whom  it  deals. 

In  times  of  crisis  and  other  periods  of  ex- 
traordinary demand,  bank  reserves  must  be 
much  larger  than  in  ordinary  times.  Hoard- 
ing, unusually  large  shipments  of  money  to 
foreign  countries  and  between  different  sec- 
tions of  the  same  country,  and  payments  of 
unusual  magnitude,  increase  the  demands  for 
cash  made  upon  banks  at  such  times. 

The  manner  in  which  clearing  and  other  bal- 
ances between  banks  are  met  also  has  an  influ- 
ence on  the  amount  of  reserves  required.  If 
such  balances  are  paid  daily  and  always  in 
cash,  the  amount  needed  for  this  purpose  is 
much  larger  than  if  they  are  paid  in  checks  on 
some  one  or  a  few  institutions  and  at  longer 
intervals. 

The  note  issue  privileges  of  a  bank  also  affect 
its  reserve  requirements.  Since,  if  not  pro- 
hibited by  law,  notes  may  be  issued  in  all 
denominations  needed  for  hand-to-hand  circu- 
lation within  a  nation,  and  since  for  all  pur- 
poses except  small  change  such  notes  are  as 
convenient  as  any  other  form  of  currency,  a 
bank  with  unrestricted  issue  privileges  can  sup- 
ply all  the  demands  of  its  customers  for  cur- 
rency for  domestic  use,  except  those  for  small 


.50  JLO 


53 


38  Banking 

change,  without  resort  to  outside  sources  of 
supply.  In  this  case,  however,  it  needs  to  keep 
a  reserve  in  order  to  meet  demands  for  the 
redemption  of  notes.  Such  demands  arise  on 
account  of  the  need  of  coin  for  small  change 
or  for  shipment  abroad  or  of  means  for  meet- 
ing domestic  clearing  and  other  bank  balances. 
The  aggregate  needed  for  the  supply  of  such 
demands,  however,  is  much  less  than  would  be 
required  if  the  privilege  of  issuing  notes  did 
not  exist. 

In  the  maintenance  of  reserves  the  chief  reli- 
ance of  commercial  banks  is  the  circulation  of 
standard  coin  within  a  nation  and  the  importa- 
tion of  such  coin.  The  coin  within  the  borders 
of  a  nation  passes  regularly  into  the  vaults  of 
banks  by  the  process  of  deposit,  and  on  account 
of  the  credit  balances  they  carry  with  foreign 
institutions,  the  loans  they  are  able  to  secure 
from  them,  the  commercial  paper  they  hold 
which  is  discountable  in  foreign  markets,  and 
the  bonds  and  stocks  sometimes  in  their  pos- 
session which  are  salable  there,  they  are  able  to 
import  large  quantities  in  case  of  need.  Since 
the  standard  coin  in  existence  in  the  world 
adjusts  itself  to  the  need  for  it  in  substantially 
the  same  manner  that  the  supply  of  any  other 
instrument  or  commodity  adjusts  itself  to  the 


Problems  of  Commercial  Banking       39 

demand,  banks  ordinarily  have  no  difficulty  in 
supplying  their  needs,  and  under  extraordinary 
circumstances,  though  difficulties  along  this  line 
sometimes  arise,  means  of  overcoming  them 
are  available  which  will  be  discussed  in  the 
proper  place. 

Jf,  as  is  the  case  in  the  United  States,  certain 
forms  of  government  notes  are  available  as 
bank  reserves,  these  find  their  way  into  the 
banks'  vaults  by  the  process  of  deposit  in  the 
same  manner  as  coin.  The  possession  of  such 
notes  by  a  bank  enables  it,  to  the  extent  of  their 
amount,  to  throw  the  responsibility  for  the 
supply  of  standard  coin  upon  the  government, 
and  in  the  circulation  of  the  country  such  notes 
take  the  place  of  an  equivalent  amount  of 
standard  coin.  Whether  or  not  a  government 
ought  to  assume  such  a  responsibility  is  a  ques- 
tion which  will  be  discussed  in  a  subsequent 
chapter. 

For  the  nation  as  a  whole,  the  balances  in 
other  banks  and  the  discountable  commercial 
paper  and  bonds  which  a  bank  may  count  as  a 
part  of  its  reserves  are  not  reserves  except  to 
the  extent  that  they  may  be  employed  as  a 
means  of  importing  gold.  They  are  only  means 
through  which  real  reserves  of  standard  coin 
are   distributed.     The  payment  in  cash  of  a 


40  Banking 

balance  with  another  bank  or  the  discount  of 
commercial  paper  with  another  domestic  bank 
or  the  sale  of  bonds  on  domestic  stock  exchanges 
do  not  add  to  the  sum  total  of  the  cash  resources 
of  the  banks  of  a  nation.  Their  only  effect  is 
to  increase  the  cash  resources  of  one  bank  at 
the  expense  of  another. 

Adequate  facilities  for  the  distribution  of 
the  reserve  funds  of  a  country,  however,  are 
second  in  importance  only  to  the  existence  of 
adequate  supplies  of  standard  coin.  If  such 
facilities  are  lacking,  existing  reserves  can  be 
only  partially  and  uneconomically  used,  with 
the  result  that  much  larger  aggregate  reserves 
are  required  than  would  otherwise  be  necessary 
and  that  the  entire  credit  system  is  much  less 
stable  than  it  otherwise  would  be. 

2.  The  Selection  of  Loans  and  Discounts 

The  problem  of  the  reserves  is  vitally  con- 
nected with  that  of  the  selection  of  loans  and 
discounts.  As  was  shown  in  the  preceding 
chapter,  the  chief  business  of  a  commercial 
bank  is  to  conduct  exchanges  by  a  process  of 
bookkeeping  between  individuals,  banks,  com- 
munities, and  nations.  This  process  consists 
primarily  in  the  converting  of  commercial  bills 


Problems  of  Commercial  Banking       41 

and  notes  into  credit  balances  and  bank  notes, 
in  the  transfer  of  such  balances  and  notes 
between  individuals  and  banks,  and  in  the  final 
extinguishment  of  such  balances  and  the  return 
of  such  notes  at  the  maturity  of  the  com- 
mercial bills  and  notes  in  which  the  process 
originated. 

In  this  process  there,  is  little  need  for  cash, 
provided  the  arrangements  between  banks  for 
clearing  checks  and  for  the  interchange  of 
notes  are  complete  and  efficiently  administered. 
But  when  a  bank  accepts  investment  in  lieu  of 
commercial  paper,  its  need  for  cash  at  once 
increases,  because  the  demand  obligations  cre- 
ated by  the  credit  balances  or  the  bank  notes 
into  which  this  paper  was  converted  are  not 
extinguished  by  payments  for  goods  purchased, 
but  must  be  met  by  cash. 

To  distinguish  between  commercial  and  invest- 
ment paper  is,  therefore,  one  of  the  chief  prob- 
lems confronting  commercial  bankers.  For  its 
solution  an  accurate  knowledge  of  the  business 
operations  of  customers  is  necessary.  An  inspec- 
tion of  the  paper  presented  and  a  general  km  rwl- 
edge  of  their  wealth  and  business  capacity  are 
important,  but  not  sufficient.  The  forms  of 
the  paper  employed  in  both  commercial  and 
investment  operations  may  be  the  same,  and  the 


42  Banking 

possession  of  wealth  does  not  ensure  the  pay- 
ment of  the  paper  at  maturity. 

The  chief  means  available  for  the  acquisition 
of  this  knowledge  are  the  requirement  from 
customers  of  frequent  statements  of  their  oper- 
ations, on  properly  prepared  forms ;  the  use, 
wherever  possible,  of  the  documented  commer- 
cial bill  of  exchange;  and  the  maintenance  of 
credit  departments  equipped  with  the  means  of 
accurately  studying  commercial,  industrial,  and 
agricultural  operations,  and  of  diagnosing  eco- 
nomic conditions.  The  study  of  carefully  pre- 
pared statements  of  customers  made  at  frequent 
intervals  reveals  to  the  banker  not  only  the 
nature  of  the  operations  represented  by  the 
paper  presented  for  discount,  but  the  trend 
of  the  business  of  his  customers  and,  through 
them,  of  the  entire  country.  With  such  knowl- 
edge, he  is  not  only  able  to  protect  his  institu- 
tion against  improper  loans  and  discounts,  but 
to  give  valuable  advice  to  his  customers,  advice 
which  no  one  else  is  in  a  position  to  give  so 
accurately. 

By  a  documented  bill  of  exchange  is  meant 
a  bill  drawn  by  a  seller  upon  the  purchaser  of 
goods,  accompanied  by  documents  evidencing 
the  transaction;  such,  for  example,  as  bills  of 
lading,  warehouse  receipts,  and  insurance  poli- 


Problems  of  Commercial  Banking       43 

cies.  The  names  on  such  bills  guide  the  banker 
in  his  efforts  to  trace  the  transaction  in  which 
it  originated  and  the  documents  enable  him 
absolutely  to  identify  it,  and  constitute  security 
for  the  loan. 

Instead  of  such  bills,  promissory  notes  made 
payable  to  banks  are  commonly  used  in  this 
country,  greatly  to  the  disadvantage  of  the  bank- 
ing business.  Such  a  note  reveals  nothing  to 
the  banker  concerning  the  purpose  for  which 
the  loan  is  made,  while  a  commercial  bill,  even 
without  documents,  reveals  the  names  of  the 
principals  of  the  transaction  in  which  the  banker 
is  asked  to  participate.  Acquaintance  with  these 
men  and  knowledge  of  the  business  in  which 
they  are  engaged  at  once  suggests  the  probable 
origin  of  the  bill  and  furnishes  the  clue  needed 
for  subsequent  investigation. 

A  properly  equipped  credit  department  will 
keep  on  file  and  at  all  times  available  for  use 
the  data  requisite  for  the  information  of  the 
officers  upon  whom  the  responsibility  of  select- 
ing the  loans  and  discounts  rests.  Such  data 
will  not  only  concern  the  character  and  business 
of  each  customer  and  the  bank's  previous  deal- 
ings with  him,  but  general  economic  conditions, 
the  operations  and  experiences  of  other  banks, 
other  business  institutions,  governments,  etc. 


44  Banking 


j.  Rates 

Besides  rates  of  exchange  considered  in  the 
preceding  chapter,  commercial  banks  are  con- 
cerned with  loan  and  discount  rates. 

Rates  on  deposits,  though  sometimes  em- 
ployed, have  no  place  in  commercial  banking, 
since  commercial  deposits  are  only  the  credit 
balances  resulting  from  loans  and  discounts  or 
from  funds  intrusted  to  the  bank  for  tempo- 
rary safekeeping  or  disbursement  in  the  interest 
of  the  depositor.  In  every  case  they  represent 
a  service  rendered  the  depositor  for  which  the 
bank  must  be  paid,  and,  when  interest  is  allowed, 
the  depositor  must  repay  it  in  some  form 
with  an  increment  sufficient  to  remunerate  said 
service. 

Commercial  banks  may  and  usually  do  con- 
duct savings  accounts  also,  for  which  an  inter- 
est payment  is  not  only  defensible  but  in  every 
sense  desirable,  but  in  so  doing  they  are  going 
beyond  the  sphere  of  commercial  banking,  which 
alone  is  under  consideration  at  this  point. 

Rates  charged  on  loans  and  discounts  are 
the  chief  means  through  which  commercial 
banks  are  remunerated  for  the  services  they 
perform.    In  the  long  run  these  rates  are  deter- 


Problems  of  Commercial  Banking       45 

mined  by  competition,  and  represent  the  current 
market  value  of  the  services  performed  by 
bankers.  Custom  often  affects  them  tempo- 
rarily and  sometimes  for  long  periods  prevents 
their  response  to  influences  tending  to  produce 
change,  but  in  the  long  run  they  yield  to 
economic  force  and  conform  to  the  laws  of 
value. 

Variations  in  the  rate  of  discount  are  the 
most  efficient  means  employed  by  commercial 
banks  for  the  regulation  of  the  volume  of 
their  loans  and  discounts  and  for  changing 
the  percentage  their  reserves  bear  to  deposits 
and  note  issues.  An  increase  of  these  rates 
tends  to  check  loans  and  discounts,  to  decrease 
deposits  and  note  issues,  to  increase  reserves, 
and  consequently  to  raise  the  percentage  of 
reserves  to  deposits  and  issues. 

It  checks  loans  and  discounts  by  increasing 
the  expense  of  conducting  business  operations 
on  a  credit  basis,  thus  diminishing  profits  and 
sometimes  causing  losses,  checking  enterprise 
and  decreasing  the  volume  of  commercial  trans- 
actions. A  decrease  of  loans  and  discounts 
correspondingly  diminishes  deposits  or  note 
issues,  or  both,  since  these  are  simply  the  coun- 
terpart or  representative  of  such  loans  and  dis- 
counts in  the  form  of  credit  balances  in  the 


46  Banking 

checking  accounts  conducted  by  the  banks  or 
the  equivalent  of  such  balances  in  a  hand-to- 
hand  money  form.  An  increase  in  the  rate  of 
discount  at  a  given  point  tends  to  attract  funds 
from  other  points  where  the  rates  are  lower 
and  thus  to  increase  reserves.  A  decrease  of 
rates  produces  opposite  effects  all  along  the 
line. 

4.  Protection  against  Unsound  Practices 

Commercial  banks  are  an  essential  part  of 
the  machinery  by  which  the  agriculture,  indus- 
try, and  commerce  of  a  country  are  carried  on, 
and  their  proper  conduct  is,  therefore,  a  matter 
of  public  concern.  On  this  account  they  have  long 
been  subjects  of  legislation  and  of  public  super- 
vision and  control.  The  methods  evolved  for 
safeguarding  the  public  against  abuses  and 
unsound  practices  differ  considerably  among 
different  nations  and  to  some  extent  among  the 
different  states  of  the  United  States,  and  could 
only  be  adequately  explained  by  a  history  of 
banking  in  each  nation.  Only  the  more  impor- 
tant and  most  widely  used  of  them  will  be 
described  here. 

(a)  Capital  and  Surplus  Requirements  and 
Double   Liability   of  Stockholders.  —  A   very 


Problems  of  Commercial  Banking       47 

common,  indeed,  almost  universal,  legal  re- 
quirement is  that  before  beginning  business 
the  proprietors  of  a  commercial  bank  shall 
contribute  a  fund  to  be  known  as  the  capital 
stock,  and  that  an  additional  fund,  usually 
called  the  surplus,  shall  afterwards  be  set 
aside  from  profits.  These  funds  are  required 
to  be  maintained  intact,  so  long  as  the  bank 
continues  in  business,  and  to  be  used  for  the 
payment  of  losses  in  case  of  failure  or  liquida- 
tion for  any  reason.  In  this  country  it  is  also 
customary  to  hold  the  proprietors  legally  liable 
in  case  of  failure  for  an  assessment  equal  to  the 
amount  of  their  capital  stock.  In  foreign  coun- 
tries it  is  a  common  practice  to  have  the  sub- 
scribed considerably  in  excess  of  the  paid-in 
capital,  the  balance  being  subject  to  call  by 
the  directors  at  any  time,  and  being  available 
for  the  payment  of  losses  in  case  of  failure. 

These  funds  serve  not  only  as  a  protection 
against  loss  to  the  customers  of  a  bank  in  case 
of  failure,  but  also  as  a  restraining  influence 
on  the  managers  in  the  everyday  conduct  of 
the  bank's  affairs.  They  constitute  the  pro- 
prietors' stake  in  the  business,  what  they  are 
likely  to  lose  if  the  management  is  imprudent, 
dishonest,  or  inefficient.  The  absence  of  such 
funds  would  put  a  premium  on  rashness  and 


48  Banking 

speculation  and   tempt   into  the  business  the 
unscrupulous  and  the  unfit. 

In  the  determination  of  the  size  of  capital 
and  surplus  funds  and  of  the  amount  of  the 
liability  of  stockholders  for  subscriptions  in 
case  of  failure,  no  well-founded  principles  have 
been  developed  for  the  guidance  of  legislators. 
They  should  be  great  enough  to  cover  prospec- 
tive losses  and  to  induce  conservatism,  honesty, 
and  efficiency  in  management,  and  not  so  great 
as  to  prevent  the  free  flow  of  an  adequate 
amount  of  capital  into  the  business.  Unfortu- 
nately, the  statistics  of  losses  in  cases  of  failure 
are  not  a  sufficient  guide.  In  some  cases  they 
bear  a  large  proportion  to  the  volume  of  busi- 
ness transacted  and  in  others  a  very  small  one, 
and  the  number  of  cases  available  are  too  small 
to  give  much  value  to  averages.  The.  amount 
necessary  to  secure  the  best  possible  manage- 
ment is  also  purely  problematical. 

In  lieu  of  well-founded  principles,  the  prac- 
tice has  developed  in  this  country  of  making 
the  minimum  capitalization  permitted  depend 
upon  the  population  of  the  town  in  which  the 
bank  is  located.  This  seems  to  be  a  very  crude 
and  indirect  method  of  proportioning  capital 
to  the  volume  of  business  transacted.  The 
fixing  of  such  a  proportion,  or  of  a  proportion 


Problems  of  Commercial  Banking       49 

which  no  bank  should  be  permitted  to  exceed, 
is  probably  the  best  method  of  solving  this 
problem,  but  it  should  be  done  directly  and 
not  by  the  roundabout  method  which  has  been 
mentioned  above. 

A  proportion  of  ten  to  one  between  capital 
and  aggregate  demand  obligations  would  prob- 
ably be  justified  by  American  experience.  The 
present  practice  of  fixing  the  surplus  fund  at 
twenty  per  cent  of  the  capital  would  be 
justifiable  if  the  capital  fund  were  properly 
regulated  in  amount. 

(b)  Inflation  and  Means  of  Protecting  the 
Public  against  It. — The  greatest  abuse  to 
which  the  business  of  commercial  banking  is 
subject,  and  against  which  the  public  most 
needs  protection,  is  inflation.  This  is  a  con- 
dition difficult  to  diagnose,  and  not  well  under- 
stood by  the  general  public  and  even  by  bankers. 
The  most  easily  recognized  symptom  of  its 
existence  is  the  forced  liquidation  of  credits; 
that  is,  forced  sales  of  property  in  order  to 
meet  maturing  obligations  to  banks.  When, 
for  example,  the  people  whose  notes  or  bills 
have  been  discounted  by  banks  default  in 
large  numbers,  and  the  collateral  deposited  as 
security  has  to  be  sold,  or,  in  the  absence  of 
collateral,   the  courts  must  order  the  sale  <>i 


50  Banking 

their  property,  the  presence  of  inflation  may  be 
suspected. 

The  chief  cause  of  inflation  is  the  issue  by 
commercial  banks  of  demand  obligations  against 
investment  securities.  The  means  of  liquidat- 
ing such  securities  are  the  profits  of  the  enter- 
prises in  which  the  investments  were  made 
and  in  the  nature  of  the  case  several  years  are 
required  for  the  accomplishment  of  this  end. 
Meantime  the  demand  obligations  of  the  banks 
issued  against  them  in  the  form  of  balances  on 
checking  accounts  or  notes  must  be  met  and, 
the  funds  regularly  deposited  with  them  as  a 
result  of  the  operation  of  such  enterprises  being 
inadequate,  other  means  must  be  found.  The 
only  one  available  is  the  sacrifice,  at  forced 
sales,  of  the  property  in  which  the  investment 
was  made  or  of  some  other  property  in  the 
possession  of  the  persons  responsible  to  the 
bank. 

The  banks  usually  protect  themselves  against 
such  forced  liquidation  by  the  requirement  that 
the  paper  they  discount  shall  mature  at  short 
intervals,  usually  not  to  exceed  four  to  six 
months,  and  accept  the  long-time  securities, 
such  as  bonds,  stocks,  and  mortgages,  only  as 
collateral.  By  this  means  they  are  able  to 
force  the  liquidation  on  their  customers.    Other- 


Problems  of  Commercial  Banking       51 

wise  they  would  be  obliged  themselves  to  endure 
it,  with  the  result  that  their  capital  and  sur- 
plus funds  would  be  impaired  and  perhaps 
exhausted;  and,  if  they  should  prove  inade- 
quate, failure  would  be  inevitable. 

The  evil  involved  in  the  forced  sales  of  prop- 
erty caused  by  inflation  is  the  readjustment  of 
prices  through  which  it  is  accomplished,  and 
the  depression  and,  sometimes,  panic  which 
follow.  When  the  prices  of  many  kinds  of 
property  must  be  greatly  depressed  in  order 
to  induce  their  transfer  to  other  hands,  the 
machinery  of  commerce  and  industry  is  thrown 
out  of  adjustment  and  is  sometimes  rendered 
temporarily  useless.  This  result  is  due  to  the 
fact  that  the  relations  between  costs  of  pro- 
duction and  the  returns  from  the  sale  of  fin- 
ished products  are  so  changed  that  profits  are 
reduced  or  annihilated,  and  many  persons  are 
financially  ruined.  Readjustments  of  the  prices 
of  raw  products,  labor,  and  finished  goods,  and 
the  transfer  of  plants  to  new  hands,  are,  there- 
fore, necessary  before  industry,  commerce,  and 
agriculture  can  again  operate  in  a  normal  way, 
and  during  the  period  of  readjustment  some 
enterprises  must  entirely  stop  operations,  and 
all  must  slow  down.  At  such  times  many 
laborers  are  thrown  out  of  employment,  many 


52  Banking 

more  work  part  time  only,  the  wages  of  nearly 
all  are  lowered,  and  most  other  classes  of 
income  are  cut  down.  Depression  and,  in 
extreme  cases,  panic  are  the  result,  and  these 
have  serious  consequences  other  than  financial. 

The  means  employed  for  the  protection  of 
the  public  against  inflation  are  crude  and  inade- 
quate. They  may  be  grouped  under  the  heads : 
regulations  regarding  investments,  reserves,  and 
note  issues.  Under  the  first  head  belong  in 
the  banking  legislation  of  this  country  limita- 
tions on  real  estate  investments  and  on  the 
amount  that  may  be  loaned  to  a  single  firm  or 
individual.  Our  national  banking  act  and  most 
of  our  state  banking  acts  prohibit  banks  from 
holding  real  estate  except  for  their  own  accom- 
modation, and  as  a  means  of  reimbursing  them- 
selves for  defaulted  loans,  and  our  national 
banking  act  prohibits  the  taking  of  real  estate 
security  for  loans,  and  many  of  our  state  bank- 
ing acts  limit  the  amount  of  such  security 
that  may  be  held.  Our  national  banking  act 
limits  the  amount  that  may  be  loaned  to  a 
single  firm  or  individual  to  one-tenth  of  the 
bank's  capital  and  surplus,  and  similar  regula- 
tions are  common  in  state  banking  legislation. 

The  purpose  of  these  regulations  is  to  con- 
fine the  investments  of  banks  to  what  are  called 


Problems  of  Commercial  Banking       53 

liquid  securities,  but  they  fail  to  evince  a  proper 
conception  on  the  part  of  their  authors  of  what 
really  makes  a  security  liquid.  Apparently 
legislators  and  their  advisers  have  felt  that  if 
the  securities  held  by  the  banks  mature  in 
short  periods,  or  are  listed  on  a  stock  exchange, 
they  are  liquid;  but  such  is  not  necessarily  the 
case. 

Commercial  paper  only  is  really  liquid,  since 
it  represents  a  current  commercial  process 
which  will  soon  be  completed  and  the  com- 
pletion of  which  automatically  provides  the 
means  for  its  payment.  Such  paper  usually 
matures  in  short  periods,  but  the  characteristic 
of  liquidity  results  not  from  the  date  at  which 
it  is  made  to  mature,  but  from  the  commercial 
process  which  called  it  into  existence  and  will 
ultimately  retire  it.  In  this  country  very  often 
paper  of  short  maturity  is  so  in  form  only,  its 
makers  expecting  to  renew  it,  instead  of  pay 
it,  at  maturity. 

Bonds  and  stocks,  even  though  they  may  be 
listed  on  a  stock  exchange  and  daily  bought 
and  sold,  are  not  liquid  securities  in  the  proper 
sense  of  that  term.  An  individual  bank  may 
be  able  to  sell  them  in  case  of  need,  but  such 
sale  is  simply  the  transfer  of  the  investment  to 
another  bank  or  person,  and  not  its  liquidation. 


54  Banking 

The  security  still  exists  and  must  be  paid,  while 
its  liquidation  would  take  it  out  of  existence. 

Foreign  legislators  have  approximated  more 
closely  than  ours  what  is  needed  in  the  regula- 
tion of  bank  investments.  In  the  case  of  their 
central  banks,  many  of  them,  notably  those  of 
France  and  Germany,  have  recognized  the  fun- 
damental distinction  between  commercial  and 
investment  paper,  and  have  required  them  to 
hold  the  former  against  their  demand  obliga- 
tions, especially  their  notes. 

The  regulation  of  reserves  has  become  a  sub- 
ject of  legislation  in  this  country  only.  Our 
national  banking  act  classifies  national  banks 
into  three  groups,  called  country,  reserve  city, 
and  central  reserve  city  banks,  and  requires 
those  in  the  first  mentioned  group  to  keep  cash 
in  their  vaults  to  the  amount  of  at  least  six 
per  cent  of  their  deposits,  and  balances  in 
approved  reserve  city  banks  sufficient  to  bring 
the  total  amount  up  to  fifteen  per  cent  of  their 
deposits. 

Banks  in  reserve  cities  are  required  to  keep 
in  their  vaults  cash  to  the  amount  of  at  least 
twelve  and  one-half  per  cent  of  their  deposits, 
and  balances  in  central  reserve  cities  sufficient 
to  bring  the  total  up  to  twenty-five  per  cent  of 
their  deposits.     Banks  in  central  reserve  cities 


Problems  of  Commercial  Banking       55 

are  required  to  keep  at  least  twenty-five  per 
cent  of  their  deposits  in  cash  in  their  vaults. 
When  the  reserves  of  a  bank  fall  to  the  pre- 
scribed minimum,  all  discounting  must  cease. 
Regulations  essentially  similar  are  found  in  the 
banking  laws  of  most  of  our  states. 

The  purpose  of  these  regulations  is  to  set  a 
limit  to  the  extent  to  which  banks  may  expand 
the  volume  of  their  loans  and  discounts,  in 
the  belief,  apparently,  that,  if  at  least  the  pre- 
scribed proportion  of  cash  is  all  the  time  kept 
on  hand,  the  banks  will  be  able  to  meet  their 
obligations.  As  in  the  case  of  the  regulations 
concerning  investments,  the  authors  of  these 
failed  to  recognize  the  significance,  from  the 
point  of  view  of  the  cash  demands  likely  to 
be  made  upon  banks,  of  the  kind  of  paper 
admitted  to  discount.  If  discounts  be  confined 
to  commercial  paper,  the  demand  obligations 
they  create  will  be  met  for  the  most  part  by 
transfers  of  credits  on  the  banks'  books  or  by 
the  return  of  the  notes  issued,  and,  as  foreign 
experience  has  demonstrated,  the  adjustment 
of  cash  resources  to  needs  can  safely  be  left 
to  the  judgment  of  the  bankers  themselves, 
who,  through  variations  in  the  discount  rate, 
rediscounts,  and  other  means,  can  regulate  it 
with  ease.     If  investment  paper  is  admitted  to 


56  Banking 

discount,  reserves  less  than  one  hundred  per 
cent  of  the  demand  obligations  thereby  created 
are  unsafe,  since  a  less  amount  is  likely  to  force 
liquidation  on  the  banks'  customers,  with  the 
results  above  indicated. 

The  most  elaborate  regulations  for  the  pre- 
vention of  inflation  have  been  developed  in 
connection  with  legislation  concerning  note 
issues.  The  reason  for  this  is  the  fact  that 
commercial  banking  was  at  its  origin  and  for 
a  long  time  thereafter  carried  on  almost  exclu- 
sively through  note  issues,  the  conduct  of 
checking  accounts  being  a  comparatively  recent 
development.  The  phenomenon  of  inflation 
was,  therefore,  first  observed  in  connection  with 
note  issues  and  associated  with  them.  Even 
now  the  essential  similarity  of  note  issues  and 
checking  accounts  as  banking  instrumentalities 
is  not  universally  recognized. 

The  means  of  safeguarding  note  issues 
which  have  been  incorporated  into  legislative 
enactments  are  the  prior  lien  on  assets,  the 
safety  fund,  the  requirement  and  sometimes  the 
mortgaging  of  special  assets,  and  the  limita- 
tion of  the  total  issues.  By  the  prior  lien  is 
meant  the  provision  that  in  case  of  failure  the 
note  holders  shall  be  paid  in  full  before  any 
of  the  assets  are  distributed  among  other  cred- 


Problems  of  Commercial  Banking       57 

itors.  By  the  safety  fund  is  meant  a  required 
contribution  from  each  bank,  usually  a  percent- 
age of  the  amount  of  notes  issued,  placed  in  the 
hands  of  some  public  official  and  kept  for  the 
redemption,  in  case  of  failure,  of  such  of  the 
notes  of  failed  banks  as  cannot  be  redeemed 
out  of  the  assets  of  the  banks  themselves.  Ad- 
ditional contributions  from  the  solvent  banks 
are  required  for  the  replenishment  of  the  fund 
when  it  has  been  depleted. 

The  practice  of  different  countries  regarding 
the  requirement  of  special  assets  to  be  held 
against  note  issues,  as  well  as  regarding  the 
mortgaging  of  such  assets,  is  not  the  same. 
Germany  and  France,  for  example,  require 
their  banks  to  cover  their  note  issues  by  desig- 
nated proportions  of  commercial  paper  and  coin, 
while  the  United  States  requires  its  banks  of 
issue  to  cover  their  notes  by  government  bonds 
and  to  contribute  a  five  per  cent  redemption 
fund  in  addition,  and  England  requires  the 
Bank  of  England  to  cover  a  designated  amount 
of  its  issues  by  government  and  other  securi- 
ties and  the  remainder  by  coin.  Unlike  the 
others,  the  United  States  mortgages  to  the  note 
holders  the  securities,  that  is,  the  government 
bonds,  required  to  be  held  against  the  notes, 
by  providing  that  in  case  of  failure  these  securi- 


58  Banking 

ties  shall  be  sold  and  the  proceeds  used  for  the 
settlement  of  their  claims. 

In  all  of  these  provisions,  the  protection  of 
note  holders  against  loss  in  case  of  failure  has 
been  an  influential  consideration,  and  in  the 
cases  of  the  prior  lien  and  the  safety  fund,  the 
only  one.  The  prevention  of  inflation  may 
have  entered  into  consideration  in  the  other 
cases,  but  among  the  states  mentioned  the 
regulations  of  France  and  Germany  alone  are 
efficient  in  this  direction,  since  they  alone  pro- 
hibit note  issues  against  investment  securities. 
The  above  mentioned  regulations  of  England 
and  the  United  States  tend  rather  to  promote, 
than  to  prevent,  inflation,  since  they  require 
the  holding  of  investment  securities  against 
note  issues. 

The  limitation  of  the  aggregate  amount  of 
notes  that  may  be  issued  is  a  common  legisla- 
tive regulation.  In  the  United  States  the  limit 
set  is  the  amount  of  the  capital  stock,  and  in 
France  it  is  an  arbitrary  figure  from  time  to 
time  changed  as  the  needs  of  the  bank  seem 
to  require.  As  a  safeguard  against  inflation, 
the  value  of  such  limitation  depends  upon  the 
basis  of  the  issues.  If  it  is  investment  securi- 
ties, as  in  the  case  of  the  United  States,  limita- 
tion to  a  low  figure,  not  in  any  case  to  exceed 


Problems  of  Commercial  Banking       59 

the  capital  stock,  is  desirable,  since  such  limita- 
tion keeps  the  inflation  within  such  bounds  that 
the  banks  themselves  may  be  able  to  withstand 
the  effects  of  it  by  selling  upon  foreign  markets, 
without  great  and  perhaps  without  any  loss, 
the  securities  in  which  their  capital  and  sur- 
plus funds  are  invested.  If  the  basis  of  issues 
be  commercial  paper,  such  limitation  is  unnec- 
essary, since  inflation  in  such  a  case  is  improb- 
able, and  pernicious,  unless  it  be  placed  above 
the  point  which  the  volume  of  issues  is  likely 
in  ordinary  cases  to  reach. 

(c)  Other  Means  of  Safeguarding  the  Inter- 
ests of  the  Public.  —  Experience  has  shown 
that  publicity  is  a  valuable  safeguard  against 
bad  bank  practices,  and  legislation  has,  there- 
fore, provided  for  it  by  the  requirement  that 
statements  of  banking  operations  shall  be 
published  from  time  to  time.  The  national 
banking  act  of  the  United  States  and  many 
of  our  state  banking  acts,  for  example,  pro- 
vide for  the  publication  five  times  a  year  of 
bank  balance  sheets,  drawn  up  according  to 
prescribeH  forms. 

The  inspection  of  banks  by  public  examiners 
and  the  requirement  of  detailed  reports  to  pub- 
lic officials  are  also  provided  for  in  our  federal 
and    state    legislation.      Canada    requires    the 


60  Banking 

reports  but  not  the  inspection  by  public  officials, 
on  the  ground  that  the  latter  cannot  be  thor- 
ough and  efficient,  and  is,  therefore,  likely  to 
mislead  the  public  and  cause  it  to  be  less  vigi- 
lant than  it  otherwise  would  be  in  the  use  of 
other  means  of  safeguarding  its  interests. 

Legislation  in  this  country  has  also  concerned 
itself  with  the  duties  of  bank  directors  and  the 
enforcement  of  their  performance,  and  with  the 
relations  of  bank  officers  to  their  banks,  particu- 
larly those  involved  in  borrowing  for  their  own 
uses  or  for  firms  or  corporations  in  which  they 
are  interested. 

A  recent  legislative  experiment  along  quite 
a  new  line  has  been  undertaken  in  this  country 
in  the  form  of  laws  providing  for  the  mutual 
insurance  of  depositors.  Oklahoma  started  this 
experiment,  and  her  example  has  been  followed 
by  other  states.  The  essence  of  the  experi- 
ment consists  in  the  provision  of  a  fund  out  of 
which  is  paid  to  the  depositors  of  failed  banks 
that  portion  of  their  claims  which  cannot  be 
met  from  the  liquidation  of  the  assets  of  the 
defunct  banks,  such  fund  to  be  contributed  by 
the  other  banks  belonging  to  the  system. 

The  protection  of  depositors  against  loss  is 
a  commendable  aim  of  legislation,  but  this 
method  of  attaining  this  aim  is  open  to  the 


Problems  of  Commercial  Banking      61 

serious  objection  that  it  removes  from  depos- 
itors all  concern  regarding  the  proper  manage- 
ment of  the  bank  with  which  they  do  business, 
and  thus  gives  the  unscrupulous,  dishonest,  and 
plunging  banker  an  advantage.  Attraction  of 
depositors  is  the  chief  field  in  which  competi- 
tion between  banks  is  carried  on,  and  when  the 
power  of  good  management  in  this  direction  is 
removed,  high  rates  on  deposits,  high  lines  of 
credit,  low  or  no  rates  of  exchange,  extrava- 
gance in  equipment,  etc.,  remain  the  only  attrac- 
tions, and  in  the  offer  of  these  the  unscrupulous 
and  plunging  banker  will  always  outdo  the 
conservative. 

It  is  impossible  to  overcome  this  objection 
by  public  supervision,  and  more  frequent  and 
rigid  examinations.  No  public  officer  can  equip 
himself  to  pass  judgment  on  the  relations  of  a 
bank  with  each  customer,  or  to  detect  secret 
contracts  and  unwritten  understandings,  or  to 
keep  unscrupulous  people  out  of  the  banking 
business.  There  can  be  no  doubt  that  a  repu- 
tation for  conservatism,  good  judgment,  strict 
integrity,  and  careful  management  is,  at  the 
present  time,  the  most  valuable  asset  a  banker 
can  have,  because  customers  know  that  they 
are  in  danger  to  the  extent  that  these  qualities 
are  lacking.    To  substitute  for  the  present  basis 


62  Banking 

of  competition  between  banks  that  established 
by  mutual  insurance  laws  is  to  undermine  the 
foundations  of  our  credit  system  and  to  invite 
disaster  and  ruin. 

5.  Adequacy  and  Economy  of  Service 

From  the  point  of  view  of  adequacy  and 
economy  of  service,  two  types  of  banking  sys- 
tems require  attention  ;  namely,  that  character- 
ized by  a  large  number  of  relatively  small  local 
independent  banks,  chartered  under  general 
laws,  and  exemplified  in  this  country;  and  that 
characterized  by  a  relatively  small  number  of 
large  banks  endowed  with  the  privilege  of 
establishing  branches,  and  exemplified  in  the 
other  leading  nations  of  the  world. 

Under  our  system  each  community  is  encour- 
aged to  look  after  its  own  banking  needs.  Local 
initiative  in  the  establishment  of  new  institu- 
tions is  given  free  play  and  local  capital  and 
local  talent  is  attracted.  Outside  promoters 
and  outside  capital  are  not  excluded,  but,  if 
they  come,  they  do  so  as  colonists  expecting  to 
cast  in  their  lot  with  the  community  and  to 
become  identified  with  it.  The  managers  of 
our  banks  for  the  most  part  are  local  men  who 
are  the  real  heads  of  the  institutions  they  man- 


Problems  of  Commercial  Banking       63 

age  and  whose  careers  and  prosperity  depend 
on  the  success  of  these  institutions. 

The  localism  which  characterizes  this  system 
contributes  elements  both  of  strength  and  of 
weakness.  It  develops  local  talent,  and  pro- 
motes mutual  understanding  and  cooperation 
between  the  banks  and  the  business  enterprises 
of  the  community,  and  conformity  of  organiza- 
tion and  methods  to  local  needs.  Its  weakness 
consists  in  the  financial  isolation  and  the  nar- 
rowness of  vision  and  training  which  are  its 
natural  accompaniments.  Under  this  system 
capital  does  not  easily  and  quickly  move  from 
place  to  place  and  readily  distribute  itself 
according  to  the  relative  needs  of  different 
communities.  In  consequence,  rates  of  inter- 
est are  apt  to  vary  widely,  some  communities 
to  be  under-  and  others  over-capitalized,  and 
the  capital  of  the  nation  as  a  whole  to  be 
inefficiently  employed.  Under  this  system  the 
opportunity  of  bankers  for  training  is  meager, 
since  the  broader  and  more  fundamental  as- 
pects of  the  business  are  rarely  brought  to  their 
attention,  and  in  the  smaller  towns  and  country 
districts  they  are  apt  to  be  recruited  from 
people  of  mediocre  ability  and  often  from  those 
not  well  fitted  by  nature  and  education  for  this 
branch  of  commercial  enterprise. 


64  Banking 

The  system  of  branch  banking,  almost  uni- 
versally employed  elsewhere,  is  strong  where 
our  system  is  weak,  but  it  has  weaknesses  of 
its  own.  It  promotes  distribution  of  capital 
according  to  relative  needs,  and  consequently 
efficiency  in  the  application  of  a  nation's  capital 
as  a  whole,  and  it  offers  a  wide  field  of  training 
for  the  people  engaged  in  the  business,  and 
draws  its  recruits  from  every  quarter.  It  can 
readily  supply  banking  facilities  to  communities 
too  small  or  too  poor  to  provide  for  an  inde- 
pendent bank,  and  more  readily  than  our 
system  can  adjust  itself  to  rapidly  growing 
communities. 

Its  chief  weakness  consists  in  the  lack  of 
independence  of  the  managers  of  the  branches 
and  the  consequent  danger  that  local  needs 
may  not  be  fully  satisfied.  The  manager  of 
a  branch  is  usually  granted  freedom  of  action 
only  in  routine  matters.  Any  business  out  of 
the  usual  order  must  be  referred  to  higher 
authorities  connected  or  associated  with  the 
main  office;  and,  even  with  the  advice  of  the 
manager,  who  alone  is  familiar  with  local  con- 
ditions, the  decision  cannot  be  made  with  that 
intimacy  of  knowledge  of  and  sympathy  with 
the  business  and  aspirations  of  the  individual  or 
firm  under  consideration   that   full  justice  to 


Problems  of  Commercial  Banking       65 

him  and  his  town  may  require.  In  the  matter 
of  adequacy  and  character  of  service,  there- 
fore, the  city  in  which  the  main  office  is  located 
has  an  advantage  over  those  in  which  the 
branches  are  located. 

In  this  connection  it  should  also  be  noted 
that,  while  the  branch  banking  system  is  able 
to  adjust  itself  to  the  capital  requirements  of 
towns  of  all  sizes  more  readily  than  the  inde- 
pendent banking  system,  and  thus  to  secure  a 
better  distribution  of  the  banking  capital  of 
the  community,  it  does  not  follow  that  it  will 
do  so.  On  account  of  ignorance  of  conditions, 
insufficiency  of  capital  or  inability  readily  to 
increase  it,  or  inertia  on  the  part  of  the  head 
office,  a  town  may  have  to  wait  for  the  estab- 
lishment of  a  branch  longer  than  it  would  for 
the  establishment  of  an  independent  bank. 

Whether  or  not  this  will  be  the  case,  how- 
ever, depends  to  a  considerable  extent  upon  the 
keenness  of  the  competition  between  the  big 
banks  with  branches.  The  big  central  banks  of 
Europe,  which  have  no  competition  within  their 
field,  have  been  slow  to  establish  branches. 
The  coercive  force  of  the  government  has  been 
necessary  in  many  cases  to  secure  their  proper 
expansion.  In  the  case  of  the  other  big  banks, 
however,  both  of  Europe  and  of  Canada,  com- 


66  Banking 

petition  has  resulted  in  very  rapid  expansion 
during  the  last  half  century,  probably  as  rapid 
as  could  be  desired. 

Regarding  adequacy  of  service,  the  method 
of  granting  charters  and  the  attitude  of  the 
government  towards  private  banking  is  impor- 
tant. If  banks  are  allowed  to  spring  up  spon- 
taneously, like  manufacturing  and  commercial 
establishments  and  farms,  they  are  likely  to  be 
plentiful  and  to  be  located  wherever  needed. 
Experience,  however,  has  shown  that  private 
banks  cannot  be  adequately  regulated  in  the 
interest  of  the  public  and  that  incorporation 
under  public  auspices  should  be  required. 

Two  methods  of  incorporation  are  employed, 
those  of  the  special  charter  and  of  the  general 
law.  Except  in  the  case  of  special  institutions, 
like  central  banks,  the  former  is  objectionable, 
since  it  opens  the  doors  to  political  favoritism 
and  is  likely  to  result  in  bad  distribution,  lack 
of  uniformity  in  regulation,  and  lack  of  steadi- 
ness and  regularity  in  development.  Incorpo- 
ration under  general  laws,  or  the  free  banking 
system,  as  it  is  sometimes  called  in  this  country, 
is  unquestionably  the  best  from  every  stand- 
point. All  the  necessary  checks  and  balances 
can  be  incorporated  in  these  laws,  and  the  super- 
vision   of    public    officers,    together    with    the 


Problems  of  Commercial  Banking       67 

necessary  administrative  machinery,  provided 
for.  This  is  the  only  practicable  method  to 
employ  in  an  independent  system  like  ours. 

The  special  charter  method  works  best  in 
connection  with  the  branch  bank  system,  in 
which  the  question  of  chartering  new  institu- 
tions only  occasionally  arises,  and  in  which 
delay  is  not  so  serious. 


CHAPTER  IV 

Commercial  Banking  in  the  United 
States 

'  I  ^HE  commercial  banking  system  of  the 
-*•  United  States  consists  of  several  elements 
which  have  been  contributed  at  different  periods 
in  our  history.  The  most  important  of  these 
are  state  banks,  national  banks,  and  the  inde- 
pendent treasury  system. 

I.  State  Banks 

From  the  very  beginning  of  our  national  his- 
tory institutions  enjoying,  among  others,  the 
privilege  of  commercial  banking  have  been 
chartered  by  our  states.  For  several  years  after 
the  adoption  of  our  constitution  it  remained  an 
open  question  whether  the  incorporation  of 
such  institutions  was  not  their  exclusive  privi- 
lege, but  in  the  case  of  McCulloch  v.  Maryland, 
in  1819,  the  Supreme  Court  decided  that  the 
federal  government  also  had  this  right. 

During  the  years  1791-1811,  and  181 6-1836, 
68 


In  the  United  States  69 

the  state  banks  had  as  competitors  the  first  and 
second  United  States  banks,  and  in  1863 
so-called  national  banks  entered  the  field,  and, 
more  recently  still,  trust  companies.  Private 
banks  have  also  existed  from  the  beginning, 
but  their  number  and  relative  importance  have 
declined  in  recent  years.  At  the  present  time 
the  number  of  state  banks  exceeds  that  of  all 
other  classes  of  banking  institutions  combined, 
but  in  capital  and  resources  they  are  inferior  to 
both  national  banks  and  trust  companies. 

Since  each  state  has  had  a  free  hand  in  the 
matter  of  legislation  concerning  the  banks  char- 
tered under  its  auspices,  uniformity  in  the  regu- 
lations imposed  upon  and  in  the  kind  and  de- 
gree of  supervision  exercised  over  this  class  of 
institutions,  is  lacking.  In  most  cases,  however, 
as  compared  to  national  banks,  the  amount  of 
capital  required  is  smaller;  they  have  greater 
freedom  in  the  making  of  loans,  especially  upon 
real  estate  security ;  and  they  are  not  so  care- 
fully examined  and  supervised  by  public  offi- 
cials. The  most  frequently  imposed  legislative 
requirements  are:  the  accumulation  of  a  sur- 
plus fund  from  earnings;  double  liability  of 
stockholders;  a  minimum  cash  reserve  to  be 
kept  in  the  vaults,  and  an  additional  reserve 
on  deposit  in  other  banks ;  the  organization  of 


jo  Banking 

a  banking  department  for  the  administration  of 
the  laws  pertaining  to  them;  regular  reports 
and  examinations ;  and  some  limitation  on  real 
estate  holdings  and  on  the  amount  of  loans  to 
be  made  on  real  estate  security.  On  account  of 
the  relatively  low  capital  requirements  imposed 
upon  them,  and  the  liberality  of  the  laws  con- 
cerning them  in  other  respects,  state  banks  have 
been  able  to  prosper  where  national  banks  and 
trust  companies  could  not  exist,  and  on  this 
account  in  many  parts  of  the  South  and  West 
they  do  most  of  the  banking  business  in  small 
towns  and  country  districts.  They  generally 
perform  a  wide  range  of  banking  functions, 
including  those  of  investment  and  savings  as 
well  as  of  commercial  banks. 

2.  National  Banks 

Our  national  banking  system  owes  its  exist- 
ence to  financial  exigencies  of  the  federal  gov- 
ernment experienced  during  the  Civil  War.  For 
a  considerable  period  preceding  the  outbreak  of 
that  struggle  the  expenses  of  the  government 
had  exceeded  its  receipts.  The  deficit  was 
greatly  increased  as  soon  as  the  war  began, 
and  Congress  did  not  find  it  possible  immedi- 
ately to  devise  adequate  new  sources  of  reve- 


In  the  United  States  yi 

nue,  including  a  market  for  government  bonds. 
It  was,  therefore,  forced  to  the  issue  of  legal- 
tender  notes  under  authority  of  an  act  passed 
February  25,  1862. 

After  three  issues  of  these  notes,  amounting 
to  $400,000,000,  had  been  exhausted,  and  the 
value  of  the  notes  had  depreciated  to  such  an 
extent  that  persistence  in  this  method  of  finan- 
ciering portended  speedy  financial  disaster,  Con- 
gress adopted  a  suggestion  made  early  in  the 
war  by  Secretary  Chase,  to  the  effect  that  a 
market  for  government  bonds  might  be  created 
by  compelling  banks  to  purchase  them  as  secu- 
rity for  their  note  issues.  An  act  passed  Feb- 
ruary 25,  1863,  provided  for  the  incorporation 
of  banks  with  the  right  to  issue  notes  on  condi- 
tion that  they  purchase  government  bonds  and 
deposit  them  with  an  official  to  be  known  as 
Comptroller  of  the  Currency. 

It  was  the  expectation  of  the  authors  of  this 
act  that  the  state  banks,  then  numbering  over 
one  thousand,  would  exchange  their  state  for 
national  charters  and  purchase  bonds  sufficient 
to  secure  their  circulation  under  the  terms  of 
the  new  act,  but,  since  they  showed  reluctance 
so  to  do,  in  1865  force  was  applied  in  the  form 
of  a  tax  of  ten  per  cent  on  bank  notes  otherwise 
secured.    Under  this  pressure  most  of  the  state 


J2  Banking 

banks  reorganized  as  national  institutions,  but 
a  few  retained  their  state  charters  and  formed 
the  nucleus  of  the  state  system  of  the  present 
day.  On  account  of  the  ten  per  cent  tax,  how- 
ever, the  issue  of  notes  by  this  remnant  became 
unprofitable,  and  the  new  national  banks  have 
to  this  day  remained  the  sole  banks  of  issue  in 
the  country. 

The  act  of  1863  has  been  amended  several 
times,  notably  in  1864,  1870,  1874,  1875,  1882, 
1887,  and  1900.  In  its  present  form  it  permits 
the  organization  of  banks  with  a  capitalization 
as  low  as  $25,000  in  towns  of  3,000  inhabitants 
or  less,  and  with  a  capitalization  as  low  as 
$50,000  in  towns  of  6,000  or  less.  Banks 
organized  under  this  act  must  put  ten  per  cent 
of  their  profits  into  a  surplus  fund  until  said 
fund  amounts  to  twenty  per  cent  of  the  capi- 
tal; must  invest  at  least  twenty-five  per  cent 
of  their  capital,  if  it  is  less  than  $200,000,  and 
at  least  $50,000,  if  it  is  $200,000  or  more,  in 
government  bonds ;  and  may  deposit  said  bonds 
with  the  Comptroller  of  the  Currency  and 
receive  circulating  notes  to  the  amount  of  their 
par  value,  provided  their  market  value  is  par 
or  above. 

The  rights  and  privileges  of  these  banks  are 
stated  in  very  broad  and  general  terms,  a  fair 


In  the  United  States  73 

interpretation  of  which  permits  them  to  engage 
in  both  commercial  and  investment  banking 
under  certain  specified  limitations,  of  which  the 
most  important  are  the  following:  they  must 
not  invest  in  or  hold  real  estate  beyond  their 
owns  needs  for  suitable  quarters,  or  tempo- 
rarily for  the  purpose  of  collecting  debts  due 
them ;  they  must  not  accept  real  estate  as  secu- 
rity for  loans;  they  must  not  loan  more  than 
ten  per  cent  of  their  capital  and  surplus  to  any 
one  person  or  firm ;  and  they  must  keep  reserves 
to  the  amount  of  fifteen  per  cent  of  their 
deposits,  if  they  belong  to  the  group  known 
as  country  banks,  and  to  the  amount  of  twenty- 
five  per  cent  of  their  deposits,  if  they  belong 
to  either  the  reserve  city  or  the  central  reserve 
city  group. 

In  the  case  of  country  banks,  at  least  two- 
fifths  of  the  required  reserves,  and  in  the  case  of 
reserve  city  banks,  at  least  one-half,  must  con- 
sist of  specified  forms  of  money  in  their  own 
vaults.  The  remainder  may  be  balances  pay- 
able on  demand  in  approved  banks  in  reserve 
or  central  reserve  cities  in  the  case  of  country 
banks,  and  in  the  central  reserve  cities  in  the 
case  of  reserve  city  banks.  In  the  case  of 
banks  in  central  reserve  cities,  the  entire  reserve 
prescribed  by  law  must  consist  of  money  in  the 


74  Banking 

vaults.  These  required  minimum  reserves  must 
not  be  infringed  upon.  When  a  bank's  cash 
and  balances  with  its  reserve  agents  fall  to 
the  prescribed  minimum,  discounting  must  be 
stopped  under  penalty  of  suspension  of  privi- 
leges and  liquidation  by  the  Comptroller  of  the 
Currency. 

At  five  dates  each  year,  selected  by  the  Comp- 
troller of  the  Currency,  national  banks  must 
make  detailed  reports  of  their  condition  on 
prescribed  blanks  and  publish  abstracts  of  such 
reports  in  local  newspapers.  They  must  also 
submit  to  examination  by  persons  appointed  for 
that  purpose  by  the  Comptroller  as  often  as  this 
official  may  deem  necessary  and  proper. 

National  banks  have  been  organized  in  every 
state  of  the  Union,  and  in  Maine,  Massa- 
chusetts, and  Vermont  they  have  completely 
supplanted  the  state  banks.  Elsewhere  they 
exist  side  by  side  with  state  banks  and  compete 
with  them.  In  some  states  they  are  more  and 
in  others  less  numerous  than  state  banks.  In 
the  kind  of  business  transacted  the  only  im- 
portant difference  between  the  two  classes  of 
institutions  consists  in  the  loans  on  real  estate 
security,  which  national  banks  are  prohibited, 
and  state  banks  allowed,  to  make.  The  latter, 
therefore,  share  this  class  of  business  with  the 


In  the  United  States  75 


trust  companies  only,  and  where  it  predom- 
inates have  a  distinct  advantage  in  competition 
over  the  national  institutions. 

3.  The  Independent  Treasury  System 

While  not  a  banking  institution,  the  Treasury 
of  the  United  States  handles  its  funds  in  such 
a  manner  and  performs  such  functions  with 
reference  to  the  currency  that  it  has  become  an 
important  part  of  the  banking  system  of  the 
country. 

Previous  to  1840  the  funds  of  the  federal 
government  were  kept  on  deposit  in  banking 
institutions,  during  the  greater  part  of  the  time 
in  the  First  and  Second  United  States  banks. 
Friction  between  President  Jackson  and  the 
Second  United  States  Bank  resulted  in  their 
withdrawal  from  that  institution  in  1834  and 
their  deposit  in  selected  state  banks,  several  of 
which  failed  and  all  of  which  suspended  specie 
payments  during  the  crisis  of  1837.  The  em- 
barrassment which  the  treasury  experienced  in 
consequence,  combined  with  previous  unsatis- 
factory relations  between  the  government  and 
its  depositories,  convinced  President  Van  Buren 
that  the  Treasurer  ought  himself  to  keep  and 
to  disburse  the  funds  of  the  government.     He 


y6  Banking 

made  a  recommendation  to  this  effect  to  Con- 
gress, which  in  accordance  therewith  enacted 
the  first  independent  treasury  act  in  1840.  The 
revival  of  agitation  for  a  third  United  States 
Bank  led  to  the  repeal  of  this  act  the  following 
year,  but  in  1846  it  was  reenacted  and  with 
modifications  has  remained  upon  our  statute 
books  to  the  present  day. 

In  its  original  form  this  act  provided  for  the 
acquisition  of  vaults  in  certain  cities,  in  which 
should  be  deposited  the  funds  of  the  govern- 
ment as  soon  as  possible  after  they  came  into 
the  hands  of  the  receiving  officers,  and  out  of 
which  should  be  taken,  upon  drafts  issued  by 
the  Secretary  of  the  Treasury,  the  money 
needed  for  the  payment  of  the  government's 
obligations.  It  further  provided  that  all  dues 
to  the  government  in  the  future  should  be  paid 
either  in  coin  or  in  currency  issued  exclusively 
by  the  government,  and  that  all  expenses  should 
be  paid  in  the  same  forms  of  money. 

Important  modifications  in  this  act  were 
made  during  and  after  the  Civil  War.  In  1863 
permission  was  granted  the  Secretary  of  the 
Treasury  to  deposit  in  national  banks  funds 
accumulated  in  the  treasury,  and  derived  from 
any  source  except  duties  on  imports,  provided 
the   banks   selected    for   this    purpose   should 


In  the  United  States  Jj 

deposit  with  him  government  bonds  for  their 
security.  Subsequently  the  discretionary  power 
of  the  Secretary  in  this  direction  was  extended 
so  that  at  the  present  time  he  is  authorized  at 
his  discretion  to  deposit  in  national  banks  sur- 
plus funds  derived  from  any  source,  trust  funds 
alone  excepted,  and  to  accept  as  security  there- 
for other  securities  than  government  bonds. 
Other  laws  have  made  national  bank  notes 
acceptable  for  certain  public  dues,  and  have 
given  the  Secretary  authority  to  issue  gold  and 
silver  certificates  against  gold  coin  and  silver 
dollars  deposited  in  corresponding  amounts, 
and  to  redeem  United  States  notes  in  gold 
coin  and  to  keep  on  hand  for  that  purpose  a 
gold  reserve  of  $150,000,000. 

In  its  operation,  this  independent  treasury 
system  affects  the  reserves  of  the  banks  and 
through  them  their  discounts  and  the  com- 
merce of  the  country.  Whenever  the  receipts 
of  the  government  exceed  its  expenditures, 
money  accumulates  in  the  treasury  and  the 
reserves  of  the  banks  are  diminished ;  and, 
under  opposite  conditions,  they  are  increased. 
The  return  of  accumulated  surplus  funds  to  the 
banks  is  possible  when  the  Secretary  of  the 
Treasury  decides  that  such  return  is  desirable 
or  necessary  and  when  the  banks  are  able  and 


yS  Banking 

willing  to  supply  the  bonds  demanded  as  se- 
curity. In  case  a  deposit  is  agreed  upon  the 
funds  go  to  a  relatively  small  number  of 
national  banks  selected  as  depositories  by  the 
Secretary  of  the  Treasury,  the  amount  allowed 
each  depository  also  being  determined  by  him. 
Through  its  ability  to  issue  gold  and  silver 
certificates,  its  obligation  to  redeem  United 
States  notes  in  gold  on  demand,  its  administra- 
tion of  the  United  States  mints  and  assay 
offices  and  the  laws  regulating  the  supply  and 
distribution  of  subsidiary  coin,  the  United 
States  Treasury  cooperates  with  the  banks  in 
the  supply  and  distribution  of  the  circulating 
medium  of  the  country.  The  people  apply  to 
the  banks  for  the  forms  of  money  and  cur- 
rency desired  and  these  institutions  meet  the 
demand  by  means  of  the  funds  deposited  with 
them  or  by  their  exchange  at  the  various  sub- 
treasuries,  if  the  forms  of  money  deposited  do 
not  correspond  with  these  demands. 

4.     The  Interrelations  of  These  Institutions 

Under  the  operation  of  the  national  banking 
act,  New  York,  Chicago,  and  St.  Louis  have 
been  designated  as  central  reserve,  and  forty- 
seven    other    cities    as    reserve    cities.      The 


In  the  United  States  79 

national  banks  in  these  reserve  cities  act  as 
reserve  agents  for  national  banks  in  the  cities 
and  towns  not  so  designated  and  ordinarily 
receive  on  deposit  the  major  part  of  their  re- 
serves plus  surplus  funds  not  needed  for  local 
purposes.  Banks  in  the  central  reserve  cities  act 
as  reserve  agents  for  the  banks  in  the  reserve 
cities  as  well  as  for  country  banks,  and  on  ac- 
count of  their  importance  as  commercial  and  in- 
vestment centers  receive  and  hold  in  the  form 
of  bankers'  balances  a  large  part  of  the  reserve 
funds  as  well  as  the  surplus  investment  funds 
of  the  national  banks  of  the  entire  country. 

State  banks  and  trust  companies  manage 
their  reserve  and  surplus  investment  funds  in 
substantially  the  same  manner  as  national 
banks,  using  national  banks  in  the  reserve  and 
central  reserve  cities  as  their  reserve  agents. 
State  laws  usually  allow  approved  state  banks 
and  trust  companies  also  to  act  as  reserve 
agents  for  the  banks  and  trust  companies  under 
their  jurisdiction,  but  these  approved  banks  are 
generally  located  in  the  reserve  and  central  re- 
serve cities,  and  themselves  employ  the  national 
banks  there  located  as  their  reserve  agents,  thus 
forming  simply  an  additional  conduit  through 
which  the  reserve  and  surplus  investment  funds 
of  state  banks  and  trust  companies  reach  the 


80  Banking 

central     money     reservoirs     administered     by 
national  banks  in  the  central  reserve  cities. 

National  banks  in  the  reserve  and  central 
reserve  cities  are  also  clearing-  centers  for  the 
enormous  volume  of  checks  and  drafts  which 
the  administration  of  the  checking  accounts  of 
the  banks  and  trust  companies  of  the  country 
bring  into  existence.  They  act  as  correspond- 
ents as  well  as  reserve  agents  for  these  other 
banks  and  trust  companies,  and  in  this  capacity 
collect  out-of-town  checks  and  drafts  and  con- 
duct checking  accounts  for  them.  Within 
these  cities,  as  well  as  in  hundreds  of  others, 
clearing  house  associations  conduct  the  local 
clearings  and  also  act  as  agencies  through 
which  national  and  state  banks  and  trust 
companies  cooperate  in  the  promotion  of 
common  interests. 

The  center  of  the  entire  system  is  in  New 
York  City.  The  clearing  house  association  of 
that  city,  consisting  of  over  fifty  national  and 
state  banks  and  trust  companies,  includes  the 
banks  the  vaults  of  which  constitute  the  central 
money  reservoir  of  the  country  and  which 
constitute  the  center  of  the  country's  clearing 
system.  Through  the  New  York  subtreasury 
pass  the  greater  part  of  the  receipts  and  dis- 
bursements of  the  government,  and  the  chief 


In  the  United  States  81 

assay  office  in  the  country  is  located  there.  The 
New  York  stock  exchange  is  our  only  stock 
and  bond  market  of  national  scope,  and  con- 
sequently the  investment  center  of  the  country. 
The  Associated  Banks  of  New  York  City, 
as  the  members  of  the  clearing  house  associa- 
tion are  called,  hold  the  greater  part  of  the 
reserves  of  the  banks  and  trust  companies  not 
required  by  law  to  be  kept  in  the  local  vaults, 
as  well  as  the  greater  part  of  the  surplus  invest- 
ment funds  of  the  entire  country.  It  is  through 
the  operation  of  the  New  York  subtreasury 
on  the  reserves  of  the  Associated  Banks  that 
the  chief  influence  of  the  independent  treasury 
system  on  the  banking  business  of  the  country 
is  exerted,  the  greater  part  of  the  government's 
receipts  coming  directly  out  of  those  reserves, 
and  a  large  part  of  the  expenditures  going  into 
them,  and  the  greater  part  of  the  money  de- 
posited in  national  banks  by  the  Secretary  of 
the  Treasury  going  directly  or  indirectly  into 
New  York  institutions.  Most  of  the  exports 
and  imports  of  coin  and  bullion  pass  through 
New  York,  and  the  major  portion  of  the 
foreign  exchanges  of  the  entire  country  are 
there  effected.  The  New  York  Assay  Office 
receives  and  distributes  the  greater  part  of  the 
new  supplies  of  gold  and  silver  bullion  which 


82  Banking 

come  from  our  mines  and  transforms  into  bul- 
lion the  major  part  of  these  metals  that  come  to 
us  from  abroad  and  do  not  find  employment  as 
foreign  coin.  The  New  York  Stock  Exchange 
is  the  medium  through  which  a  large  part  of 
the  surplus  savings  of  the  country  are  invested 
in  our  industries  or  loaned  for  the  use  of  our 
national,  state,  municipal,  and  other  local  gov- 
ernmental agencies. 

5.  Operation  of  the  System 

The  most  noteworthy  features  of  the  work- 
ing of  this  machinery  may  be  discussed  under 
the  heads :  conflict  of  functions  and  laws ;  loan 
operations ;  treasury  operations ;  reserve  sys- 
tem; absence  of  elasticity  in  the  currency. 

(a)  Conflict  of  Functions  and  Laws.  —  The 
two  classes  of  banking  institutions  which  have 
been  described  (state  banks  and  national  banks) 
and  trust  companies,  described  in  a  subsequent 
chapter,  exist  side  by  side  in  many  communi- 
ties, and  in  the  performance  of  certain  services 
compete  for  the  patronage  of  the  public.  As 
has  already  been  pointed  out,  state  and  national 
banks  differ  little  in  their  functions  except  in 
their  relation  to  real  estate  loans,  and  in  some 
states  trust  companies  perform  all  the  func- 


In  the  United  States  83 

tions  of  these  institutions  and  many  others 
besides.  In  the  performance  of  these  common 
services,  however,  they  are  rarely  regulated  by 
the  same  laws  or  subjected  to  the  same 
kind  or  degree  of  public  supervision.  The  com- 
petition between  them,  therefore,  is  not  always 
on  a  fair  basis  and  the  temptation  to  violate 
restraining  laws  and  administrative  regulations 
is  strong.  The  supervising  officers  recognize 
the  situation  as  a  rule  and  go  to  the  extreme 
limit  of  leniency  in  administering  laws  and 
regulations  which  operate  to  the  manifest  dis- 
advantage of  the  institutions  over  which  they 
have  jurisdiction,  but  even  then  it  is  often  im- 
possible to  render  the  basis  of  competition  fair 
and  equitable. 

.  This  condition  of  affairs  has  resulted  in  the 
devising  of  ways  and  means  of  circumventing 
obnoxious  laws  and  in  some  cases  in  practices 
which  are  pernicious  in  themselves.  As  exam- 
ples may  be  mentioned  the  widespread  practice 
of  national  banks,  which  are  prohibited  by  law 
from  making  loans  on  real  estate  security,  of 
making  loans  to  customers  who  can  offer  no 
other  collateral,  on  the  security  of  their  personal 
notes  only,  or  of  making  loans  secured  by  real 
estate  by  a  three  cornered  operation  utilizing 
a  director  or  officer  or  some  other  third  party 


84  Banking 

as  intermediary.  All  three  classes  of  institu- 
tions compete  in  soliciting  the  savings  deposits 
of  the  community,  with  the  result  that  the  trust 
companies  and  savings  banks,  which  often  have 
the  advantage  here,  sometimes  force  upon  their 
state  and  national  bank  competitors  a  higher 
rate  of  interest  on  such  deposits  than  they 
ought  to  pay.  The  differing  regulations  in 
some  places  in  force  regarding  the  amount  that 
may  be  loaned  to  a  single  individual  or  firm 
has  also  resulted  in  some  cases  in  devious  and 
uncommendable  practices. 

For  the  remedy  of  these  conditions  the  first 
desideratum  is  the  careful  differentiation  of 
the  various  functions  performed  by  all  these 
institutions,  and  the  devising  of  appropriate 
legal  and  administrative  regulations  for  each 
one.  These  regulations  should  then  be  incor- 
porated into  the  legislation  and  the  adminis- 
trative practices  of  the  federal  government  and 
of  each  state,  and  any  institution  which  per- 
forms any  of  these  functions  should  be  obliged 
to  submit  to  the  regulations  pertaining  thereto. 
The  difficulties  in  the  way  of  securing  such  a 
differentiation  of  functions  and  such  com- 
munity of  action  between  the  federal  govern- 
ment and  our  states  are  too  obvious  to  require 
statement,  but  they  should  not  prevent  the  for- 


In  the  United  States  85 

mulation  of  ideal  conditions,  and  a  conscious 
and  persistent  effort  to  attain  them. 

( b)  Loan  Operations.  —  In  making  loans,  a 
typical  method  of  procedure  for  a  business  man 
is  to  arrange  with  a  bank  for  what  is  tech- 
nically called  a  "line,"  that  is,  the  maximum 
amount  he  may  expect  to  be  able  to'  borrow 
under  normal  conditions.  This  "line"  deter- 
mined, he  borrows  from  time  to  time  accord- 
ing to  his  needs,  giving  as  security  his  personal 
note,  payable  in  one,  two,  three,  four,  or  six 
months.  Sometimes  an  indorser  is  required, 
and  sometimes  the  deposit  of  collateral,  mort- 
gages on  real  estate,  bonds,  stocks,  and  ware- 
house receipts  being  the  most  commonly  used 
securities  employed  in  such  cases.  Ordinarily, 
when  a  note  falls  due,  he  expects  the  bank 
to  renew  it,  if  its  payment  at  the  time  is 
not  convenient,  the  agreement  on  a  "  line  of 
credit "  ordinarily  carrying  with  it  that  impli- 
cation, though  not  legally,  probably  not  mor- 
ally, binding  the  bank  so  to  do.  Indeed,  the 
customer  ordinarily  counts  the  amount  of  his 
"  line "  as  a  part  of  his  working  capital  and 
expects  to  keep  it  in  use  a  large  part,  if  not  all, 
of  the  time. 

In  the  determination  of  the  amount  of  these 
"lines  of  credit,"  the  judgment  of  some  one 


86  Banking 

or  more  bank  officers,  assisted  by  a  discount 
committee  and  sometimes,  though  not  as  a  rule, 
by  a  specially  organized  credit  department, 
rules.  In  forming  these  judgments,  the  bankers 
of  the  United  States  as  a  class  are  not  guided 
by  any  universally  recognized  and  well  estab- 
lished principles.  The  best  ones  require  from 
their  customers  carefully  prepared  statements 
showing  the  nature  and  volume  of  the  business 
they  transact,  and  a  careful  classification  of 
their  assets  and  liabilities.  Others,  and  these 
are  a  large  majority,  rely  upon  the  knowledge 
they  already  possess,  gained  by  general  obser- 
vation, and  supplemented  by  verbal  inquiries 
made  from  time  to  time  and  by  the  voluntary 
statements  of  the  customers  themselves. 

The  significance  of  the  distinction  between 
commercial  and  investment  operations  in  the 
business  of  banking  is  not  generally  under- 
stood, and  is  consequently  little  regarded.  The 
dominant  question  in  the  mind  of  the  average 
banker,  both  in  determining  the  amount  of  a 
customer's  line  and  in  making  loans  to  him 
after  the  line  is  fixed,  is  how  much  he  is  "good 
for,"  and  on  this  point  the  total  net  worth, 
rather  than  the  nature  of  the  business  opera- 
tions, of  the  customer  is  likely  to  be  decisive. 
Of  course,  the  banker  is  also  influenced  by  the 


In  the  United  States  87 

customer's  reputation  for  both  integrity  and 
business  ability. 

This  method  of  procedure  has  the  advantage 
of  rendering  access  of  people  to  the  banks  easy 
and  of  promoting  their  extensive  use,  but  it 
has  the  grave  disadvantage  of  opening  the  doors 
wide  to  inflation  of  credit.  The  majority  of 
our  bankers  do  not  know  whether  more  or  less 
than  their  savings  deposits  and  their  capital  and 
surplus,  the  only  funds  which  can  safely  be 
invested  in  fixed  forms,  is  so  invested.  The 
promissory  notes  of  their  customers,  which  con- 
stitute the  major  part  of  their  assets,  give  no 
information  on  this  point,  and  they  have  not 
made  the  investigations  necessary  to  determine 
with  certainty  the  destination  of  the  funds 
they  have  loaned.  They  are  satisfied  with  the 
knowledge  or  the  conviction  that  their  loans 
can  be  collected,  not  at  maturity  —  they  know 
very  well  that  many,  probably  most,  of  them 
can  not  —  but  ultimately.  The  result  is  that  un- 
consciously and  gradually  the  banks  create  their 
demand  obligations  in  the  form  of  balances 
on  checking  accounts  against  fixed  investments 
in  machinery,  buildings,  lands,  mines,  etc., 
and,  when  the  payment  of  these  obligations  is 
demanded,  the  reserves  fall  below  the  danger 
point  and  they  are  forced  to  require  payment 


88  Banking 

at  maturity  of  paper  which  the  maker  had 
counted  upon  having  renewed  indefinitely,  and 
the  payment  of  which  is  only  possible  by 
the  forced  sale  of  the  property  in  which  the 
borrowed  funds  were  invested,  or  of  some 
other  property  in  his  possession.  If  only  a 
single  bank  or  a  comparatively  few  banks  find 
themselves  in  this  condition,  relief  may  be 
found  in  the  rediscount  of  paper  with  other 
banks,  in  direct  loans,  or  in  the  sale  of  securi- 
ties on  the  exchanges;  but,  if  the  condition  is 
general,  relief  by  these  means  is  impossible, 
and  widespread  forced  liquidation  becomes  nec- 
essary. An  aggravated  situation  of  this  kind 
causes  panic  and  results  in  a  commercial  crisis. 
(c)  Treasury  Operations.  —  The  operation 
of  our  independent  treasury  system  produces 
arbitrary  fluctuations  in  the  reserves  of  the 
banks  and  prevents  that  degree  of  prevision 
which  is  essential  to  the  most  economical  and 
the  safest  practices.  The  funds  needed  for  cur- 
rent purposes  are  withdrawn  from  the  banks 
and  kept  under  lock  and  key  in  the  treasury 
vaults,  thus  diminishing  reserves  to  the  extent 
of  their  amount.  Surplus  funds  likewise  ac- 
cumulate in  the  vaults  with  the  same  result, 
until  the  Secretary  of  the  Treasury  sees  fit  to 
deposit,  and  the  banks  find  it  possible  to  receive 


In  the  United  States  89 

them.  Even  then  the  depository  banks  alone 
are  directly  benefited,  and  no  one  of  these 
knows  long  in  advance  how  much  it  is  going 
to  receive  or  when  funds  left  on  deposit  will 
be  withdrawn. 

Since  the  volume  of  the  business  of  the  gov- 
ernment is  very  large,  the  effects  produced  by 
the  movement  of  its  funds  are  of  such  magni- 
tude as  to  give  them  national  importance,  the 
ability  of  banks  to  loan  and  to  meet  obliga- 
tions already  incurred  being  profoundly  affected 
by  them.  Among  these  effects  must  also 
be  noted  the  inability  of  the  banks  to  calcu- 
late these  movements  in  advance,  as  they  to  a 
degree  can  those  produced  by  the  operations  of 
their  commercial  customers,  and  the  relation 
between  them  and  the  Secretary  of  the  Treas- 
ury, which  results.  The  relation  between  the 
receipts  and  the  disbursements  of  the  govern- 
ment vary  greatly  from  month  to  month  and 
year  to  year,  so  that,  on  the  basis  of  past 
experience,  it  is  impossible  to  predict  when  the 
banks  will  gain  from  or  lose  to  the  treasury. 
The  action  of  the  Secretary  of  the  Treasury 
regarding  deposits  of  surplus  funds  is  equally 
uncertain  and  unpredictable.  No  fixed  policy 
regarding  this  matter  lias  yet  been  established 
by  precedent   or  determined   by   law.       Each 


90  Banking 

secretary  follows  his  own  judgment  and  is 
influenced  by  current  events  and  conditions. 

The  uncertainty  which  results  creates  a  spec- 
ulative atmosphere  about  the  money  market  and 
renders  the  banks  dependent  upon  the  secre- 
tary and  the  secretary  influential  on  the  money 
market  in  a  manner  which  is  unfortunate  for 
both.  Since  they  cannot  be  indifferent  to  the 
operations  of  the  treasury,  and  cannot  predict 
them,  banks  are  obliged  to  speculate  regarding 
them,  and,  if  they  err,  they  are  likely  either 
to  over-extend  their  credit  operations  or  unduly 
to  contract  them.  The  former  will  result  when 
they  expect  an  increase  in  their  reserves  from 
treasury  sources  and  do  not  get  it,  and  the 
latter  when  contemplated  withdrawals  of  funds 
do  not  occur. 

The  Secretary  of  the  Treasury  is  not  in  a 
position  properly  to  exercise  the  power  con- 
ferred upon  him.  He  is  outside  the  channels  of 
commerce  and  industry,  and  must,  therefore, 
secure  at  second  hand  the  information  neces- 
sary for  intelligent  action.  Such  sources  of 
information  are  frequently  unreliable  and 
inaccurate  and  their  use  subjects  him  to  the 
charge  of  favoritism  and  to  the  danger  of  act- 
ing in  the  interest  of  special  groups  or  special 
localities. 


In  the  United  States  91 

(d)  Operation  of  the  Reserve  System. — 
Each  national  bank  now  keeps  locked  up  in  its 
vaults  money  to  the  amount  of  at  least  six  to 
twenty-five  per  cent  of  its  deposits  and  a  bal- 
ance with  banks  in  reserve  and  central  reserve 
cities  sufficient  to  bring  the  total  to  at  least  fif- 
teen per  cent  of  deposits  in  the  case  of  country 
banks,  and  twenty-five  per  cent  of  deposits  in 
the  case  of  reserve  city  banks.  In  addition,  it  is 
customary  for  most  banks  to  carry  as  a  sec- 
ondary reserve  high-grade  bonds  which  can  be 
readily  sold  in  case  of  need.  The  practice  of 
state  banks  is  practically  the  same  as  that  of 
national,  and  that  of  trust  companies  differs 
only  in  the  amount  of  reserves  carried  and 
in  the  proportion  between  the  different  items. 

This  system  has  many  disadvantages. 
Among  them  the  most  obvious,  perhaps,  is  the 
withdrawal  of  enormous  sums  from  the  current 
use  of  the  agriculture,  industry,  and  commerce 
of  the  country.  That  portion  of  these  reserve 
funds  which  is  required  to  be  kept  under  lock 
and  key  in  the  vaults,  amounting  in  the  aggre- 
gate to  a  billion  and  a  half  of  dollars  or  more, 
is  not  available  for  use  in  ordinary  times,  and 
is  practically  useless  even  in  times  of  strin- 
gency, since  according  to  present  law,  when 
the  reserves  fall  to  the  minimum  prescribed  by 


92  Banking 

law,  banks  must  stop  discounting,  under  pen- 
alty of  being  put  in  the  hands  of  a  receiver. 
The  other  portions  of  these  funds,  namely, 
those  deposited  with  banks  in  reserve  cities 
and  those  invested  in  bonds,  are  likewise  with- 
drawn from  the  uses  of  current  commerce, 
since  a  large  part  of  the  former  is  only  avail- 
able for  use  on  the  New  York  Stock  Exchange, 
and  the  latter  are  invested  in  railroads,  mines, 
factories,  land,  etc. 

The  explanation  of  the  devotion  of  the  rede- 
posited  portion  of  the  reserves  to  the  operations 
of  the  New  York  Stock  Exchange  is  to  be 
found  in  the  fact  that  that  exchange  furnishes 
a  regular  market  for  call  loans  on  a  large  scale. 
Since  these  funds  are  held  subject  to  the  call 
of  the  banks  which  deposited  them,  and  interest 
at  the  rate  of  at  least  two  per  cent  is  paid  upon 
them,  the  depository  banks  are  bound  to  seek 
investment  for  them,  and  call  loans  on  collateral 
listed  on  the  exchange  under  ordinary  circum- 
stances are  best  suited  to  their  purposes. 

Another  disadvantage  of  this  reserve  system 
is  the  dangerous  situation  in  which  it  places 
banks  from  time  to  time,  and  the  tendency  to 
panic  which  it  fosters.  The  demands  made 
upon  banks  for  both  cash  and  credit  vary  with 
the  seasons.     In  the  fall  and  spring  they  are 


In  the  United  States  93 

much  greater  than  in  the  winter  and  summer. 
They  also  vary  regularly  through  periods  of 
years,  increasing  during  the  up-grade  of  a  credit 
cycle  and  decreasing  for  a  longer  or  shorter 
period  after  a  crisis.  Irregular  and  unexpected 
events  also  cause  variations.  On  account  of  the 
rigidity  of  this  reserve  system  and  the  lack  of 
elasticity  in  our  currency,  the  means  available 
to  banks  for  meeting  increased  demands,  espe- 
cially those  of  an  irregular  and  unexpected 
character,  are  inadequate,  and  their  employment 
is  often  dangerous.  These  means  are :  keeping 
in  the  vaults  in  slack  times  a  large  amount  of 
unused  cash,  a  practice  too  expensive  to  be 
employed;  keeping  surplus  balances  with  cor- 
respondents at  two  or  three  per  cent  interest, 
not  a  sufficiently  remunerative  practice  to  be 
employed  on  a  sufficiently  extensive  scale;  redis- 
count with  correspondents  of  some  of  their 
customers'  paper,  or  loans  from  them  on  the 
security  of  their  own  signatures  or  on  such 
security  supplemented  by  collateral;  and  sale 
of  bonds  at  such  prices  as  they  will  bring. 

None  of  these  expedients  is  certain  at  all 
times  and  under  all  conditions,  and  some  of 
them  are  precarious  at  all  times.  Surplus  bal- 
ances with  correspondents  are  most  reliable, 
but  they  occasionally   fail  on  account  of  the 


94  Banking 

inability  of  correspondents  to  realize  upon  their 
call  loans.  When  calls  for  the  payment  of  bal- 
ances are  large  and  general,  it  is  impossible  for 
brokers  whose  loans  are  called  by  one  bank  to 
transfer  them  to  another.  The  collateral  depos- 
ited as  security  must,  therefore,  be  offered  for 
sale  on  the  stock  exchange,  and  the  very  strin- 
gency which  resulted  in  their  being  so  offered 
renders  their  sale,  even  at  slaughter  prices, 
difficult  and  sometimes  impossible.  The  result 
at  the  best  is  a  heavy  fall  in  the  prices  of  stock- 
market  securities,  and  at  the  worst  a  stock- 
market  panic  and  a  suspension  of  payments  by 
the  banks. 

Rediscounts  and  loans  from  correspondent 
banks  cannot  be  depended  on.  Correspondents 
are  under  no  obligation  to  make  them.  They 
will  usually  do  so  as  a  favor,  if  their  condition 
warrants,  otherwise  not.  Sales  of  bonds  on 
the  stock  exchange  are  difficult  and  sometimes 
impossible  in  time's  of  emergency,  and  are 
usually  attended  with  loss. 

On  account  of  this  uncertainty  and  the  dan- 
ger attending  it,  when  new  and  unusual  condi- 
tions likely  to  result  in  increased  demands  upon 
them  arise,  banks  are  likely  to  act  "  panicky  " ; 
to  call  in  their  balances  from  correspondents ;  to 
sell  bonds ;  to  call  loans ;  and  greatly  to  curtail 


In  the  United  States  95 

or  absolutely  to  cut  off  new  discounts.  This 
action  spreads  the  panicky  feeling  among  their 
customers,  and  creates  such  pressure  at  the 
reserve  centers  as  to  cause  curtailment  of  accom- 
modations and  panic  there. 

At  the  very  best,  this  reserve  system  is  accom- 
panied by  high  discount  and  loan  rates  and  by 
speculation  on  the  stock  market.  High  rates 
result  inevitably  from  the  hoarding  of  currency 
which  it  involves,  the  supply  of  loan  funds 
being  abnormally  diminished,  and  speculation 
follows  from  the  concentration  in  slack  times 
of  funds  in  New  York  City,  which  can  only  be 
employed  in  call  loans  on  stock-exchange  col- 
lateral. Stock  brokers  regularly  take  advan- 
tage of  this  situation,  speculate  themselves  and 
inspire  speculation  among  their  customers.  The 
mutual  dependence  of  the  stock  and  money 
markets  thus  produced  by  this  reserve  system 
is  disadvantageous  to  both,  fluctuations  in 
values,  uncertainty,  and  irregularity  on  both 
being  the  result. 

(e)  Lack  of  Elasticity  in  the  Currency.  — 
The  money  of  the  United  States  consists  of 
four  main  elements,  gold  and  silver  coin, 
United  States  notes,  and  national  bank  notes, 
and  none  of  these  fluctuate  in  volume  in  accord 
with  the  needs  of  commerce. 


96  Banking 

The  gold  element  depends  primarily  upon  the 
output  of  our  gold  mines  and  upon  the  inter- 
national movement  of  gold,  increasing  when 
that  output  increases  and  when  our  imports  of 
gold  exceed  our  exports,  and  decreasing  under 
opposite  conditions.  These  fluctuations,  how- 
ever, are  quite  independent  of  our  commercial 
needs.  Silver  dollars,  which  constitute  the 
major  part  of  our  silver  currency,  for  several 
years  have  been  unchanged  in  quantity,  and  the 
volume  of  United  States  notes  has  remained 
at  $346,681,016  since  the  resumption  of  specie 
payments,  January  1,  1879. 

National  bank  notes  fluctuate  in  volume  as 
a  result  of  changes  in  the  number  of  national 
banks  and  in  the  prices  of  government  bonds. 
Whenever  a  new  national  bank  is  organized,  a 
specified  portion  of  its  capital  must  be  invested 
in  government  bonds,  which  bonds  are  usually 
deposited  with  the  Comptroller  of  the  Cur- 
rency in  exchange  for  notes ;  and,  when  the 
price  of  government  bonds  rises,  banks  holding 
more  than  the  minimum  required  by  law  fre- 
quently retire  a  portion  of  their  circulation  in 
order  to  recover  their  bonds  for  sale  at  the 
enhanced  price.  When  the  price  of  govern- 
ment bonds  falls,  many  banks  purchase  addi- 
tional quantities  and  increase  their  circulation. 


In  the  United  States  gy 

Changes  in  the  price  of  government  bonds 
and  in  the  number  of  national  banks,  however, 
have  no  connection  whatever  with  changes  in 
our  currency  needs,  and  no  more  do  the  fluc- 
tuations in  the  volume  of  the  currency  as  a 
whole,  made  up  of  these  various  elements  com- 
bined. As  a  result  of  this  condition,  rates  on 
loans  and  discounts  fluctuate  greatly  on  account 
of  wide  variations  between  the  demand  and 
the  supply  of  loan  funds,  and  commerce  is  ham- 
pered at  certain  seasons  and  overstimulated  at 
others.  As  was  indicated  above,  this  lack  of 
elasticity  in  our  currency  aggravates  the  de- 
fects of  our  reserve  system  and  also  aids  in 
the  production  of  financial  panics. 

6.  Plans  for  Reform 

On  account  of  the  defects  in  our  system  of 
banking,  there  has  been  long-continued  agita- 
tion for  reform,  increasing  in  scope  and  inten- 
sity in  recent  years.  After  the  crisis  of  1907, 
which  revealed  these  defects  to  many  persons 
who  had  not  observed  them  before,  Congress 
appointed  a  commission  to  make  investigations 
and  to  prepare  a  reform  measure.  In  January, 
191 2,  this  committee  submitted  a  report  which 
embodied   a   bill    for   the   incorporation  of   a 


98  Banking 

National  Reserve  Association,  to  be  made  up 
of  a  federation  of  local  associations  of  banks 
and  trust  companies.  The  purpose  of  this  asso- 
ciation was  to  supply  a  market  for  commercial 
paper,  an  elastic  element  in  the  currency,  a 
place  for  the  deposit  of  the  bank  reserves  of 
the  country  and  of  the  funds  of  the  govern- 
ment, as  well  as  proper  machinery  for  the 
administration  of  this  market  and  these  funds. 

For  various  reasons,  the  plan  of  the  mone- 
tary commission  did  not  meet  with  universal 
favor.  It  was  condemned  in  particular  by  the 
Democratic  party,  which  was  victorious  at  the 
polls  in  the  fall  elections,  and  installed  a  new 
administration  in  Washington,  March  4,  19 13. 
A  special  session  of  the  new  Congress  was 
called  to  consider  the  tariff  question,  and  to  it 
was  submitted  another  plan  for  the  reform  of 
our  banking  system,  which  was  enacted  into 
law  December  23,  19 13. 

This  law  provides  for  the  incorporation  of 
so-called  "Federal  Reserve  Banks,"  the  number 
to  be  not  less  than  eight  or  more  than  twelve. 
The  country  is  to  be  divided  into  as  many  dis- 
tricts as  there  are  Federal  Reserve  Banks,  and 
the  national  banks  in  each  district  must  sub- 
scribe six  per  cent  and  pay  in  three  per  cent  of 
their  capital  and  surplus  to  the  capital  stock  of 


In  the  United  States  99 

the  Federal  Reserve  Bank  located  in  that  dis- 
trict. State  banks  and  trust  companies  may 
contribute  on  compliance  with  the  same  con- 
ditions as  national  institutions.  If,  in  the 
judgment  of  the  organization  committee,  the 
amount  of  stock  thus  subscribed  is  inadequate, 
the  public  may  be  asked  to  subscribe,  and  as  a 
last  resort  stock  sufficient  to  raise  the  total  to 
an  adequate  figure  may  be  sold  to  the  Federal 
Government.  Cooperation  between  these  Fed- 
eral Reserve  Banks  and  a  degree  of  unity  in 
their  administration  are  provided  for  through 
a  Federal  Reserve  Board  of  seven  members, 
two  ex  officio  and  five  to  be  especially  ap- 
pointed by  the  President  of  the  United  States. 
For  the  administration  of  each  Federal  Reserve 
Bank,  a  board  of  directors  of  nine  members  is 
provided  for,  six  to  be  appointed  by  the  member 
banks  and  three  by  the  Federal  Reserve  Board, 
one  of  those  three  to  be  designated  as  Federal 
Reserve  Agent  and  to  be  the  intermediary  be- 
tween the  Federal  Reserve  Board  and  the  bank 
of  whose  directorate  he  is  a  member. 

The  proposed  Federal  Reserve  Banks  are  to 
hold  a  part  of  the  reserves  of  member  banks 
and  to  rediscount  commercial  paper,  administer 
exchange  accounts,  and  conduct  clearings  for 
them.     They  are  also  to  serve  as  depositories 


ioo  Banking 

for  the  United  States  government,  and  to 
issue  treasury  notes  obtained  from  the  Federal 
Reserve  Board  in  exchange  for  rediscounted 
commercial  bills,  these  notes  to  be  redeemable 
on  demand  by  them  and  to  be  a  first  lien  on  all 
their  assets.  Their  retirement,  when  the  need 
for  them  has  passed,  is  provided  for  by  the 
requirement  that  no  Federal  Reserve  Bank  shall 
pay  out  any  notes  except  its  own,  all  others 
being  sent  in  to  the  issuing  bank  or  to  the 
treasury  for  redemption.  Against  outstanding 
note  issues  a  reserve  of  at  least  40  per  cent  in 
gold  must  be  maintained,  and  against  deposits 
one  of  at  least  35  per  cent  in  gold  or  lawful 
money. 

This  law  provides  remedies  for  the  chief 
defects  of  our  system;  namely,  a  market  for 
commercial  paper  which  will  enable  a  properly 
conducted  bank  at  any  time,  through  redis- 
counts, to  secure  notes,  legal-tender  money,  or 
checking  accounts  in  the  amounts  needed ;  a 
system  of  note  issues  which  will  fluctuate  auto- 
matically with  the  needs  of  commerce  for 
hand-to-hand  money;  a  more  economical  ad- 
ministration of  the  reserve  funds  of  the  coun- 
try, unattended  by  the  dangers  of  the  present 
system,  and  an  administration  of  the  funds  of 
the  federal  government  which  is  free  from  the 
evils  of  the  independent  treasury  system. 


CHAPTER  V 

Commercial  Banking  in  Other  Countries 

FN  contrast  with  that  of  the  United  States, 
-*-  the  characteristic  features  of  the  commer- 
cial banking  systems  of  Europe  are  the  central 
bank  performing  important  functions  for  all 
other  financial  institutions  and  for  the  govern- 
ment; a  relatively  small  number  of  large  insti- 
tutions with  many  branches  mediating  between 
the  central  bank  and  the  people ;  and  the  use  of 
commercial  and  bank  bills  instead  of  promis- 
sory notes  as  the  chief  instruments  of  loans 
and  discounts. 

i.  Common  Features 

The  central  banks  differ  considerably  in 
organization  and  business  methods,  but  perform 
essentially  the  same  functions ;  that  is,  they 
act  as  financial  agents  for  their  respective  gov- 
ernments; discount  high-grade  commercial  and 
bankers'  bills  for  other  banks  and  usually  for 
private  persons;    administer  the  cash  reserves 

101 


102  Banking 

of  the  entire  country;  and  furnish  the  greater 
part  and,  in  some  cases,  the  entire  supply  of 
bank  notes. 

The  other  large  banks  do  most  of  the  busi- 
ness with  the  public,  the  central  bank's  rela- 
tions being  chiefly  with  them  and  with  the 
government.  They  conduct  checking  accounts 
with  merchants,  manufacturers,  farmers,  and 
others ;  receive  and  invest  savings  deposits,  and 
deal  in  certain  classes  of  investment  securities; 
conduct  the  domestic  and  foreign  exchanges; 
discount  various  kinds  of  commercial  and  bank- 
ing bills,  frequently  those  not  available  for  dis- 
count at  the  central  bank;  and  make  advances 
on  personal  and  other  kinds  of  security.  Their 
main  offices  are  located  either  in  the  central 
money  market  of  the  country  or  in  important 
financial  centers,  and  their  branches  are  extended 
to  all  places  in  which  banking  facilities  are  sup- 
posed to  be  needed.  As  a  rule,  they  are  less 
restricted  by  legislative  provisions  than  are  the 
national  and  state  banks  and  trust  companies 
of  the  United  States,  and  are  less  carefully 
supervised  and  inspected  by  public  officers. 

Commercial  and  bankers'  bills  are  widely 
used  as  credit  instruments  between  buyers  and 
sellers  and  between  bankers  and  their  cus- 
tomers.   A  common  method  of  procedure,  when 


In  Other  Countries  103 

a  sale  is  made  on  time,  is  the  drawing  of  a  bill 
for  the  amount  due,  by  the  seller  upon  the 
buyer,  payable  at  the  end  of  the  credit  period 
agreed  upon,  and  accepted  by  the  buyer,  and 
the  discount  of  the  bill  by  the  seller's  bank.  In 
foreign  and  in  some  branches  of  domestic  trade, 
the  banker's  bill  is  used  on  account  of  its  more 
general  acceptability  as  an  object  of  discount, 
such  bills  usually  being  discountable  by  the  cen- 
tral bank  and  by  banks  far  distant  from  the 
place  in  which  the  bill  originated. 

In  case  a  buyer  desires  to  furnish  his  cred- 
itors with  bills  of  this  kind,  he  arranges  with 
his  banker  for  a  line  of  "acceptance"  credit, 
which  permits  people  who  sell  goods  to  him  to 
draw  bills  upon  his  banker  instead  of  himself, 
the  banker  agreeing  to  accept  the  bill  and  guar- 
anteeing its  payment  at  maturity.  The  seller 
will  usually  have  no  difficulty  in  discounting 
such  a  bill  at  his  own  bank,  no  matter  how  far 
removed  it  may  be  from  the  home  of  the 
buyer,  the  character  of  the  accepting  bank 
being  known  throughout  the  financial  world. 
"Acceptance  lines"  are  usually  granted  only  on 
condition  that  the  customer  agrees  to  supply 
the  bank  with  the  funds  necessary  for  meeting 
the  accepted  bills  as  they  fall  due,  and  to  pay 
a  fee  for  the  accommodation.     Ample  security 


104  Banking 

that  these  obligations  will  be  met  is  usually 
demanded. 

2.  The  English  System 

In  the  English  system,  the  central  bank  is  the 
Bank  of  England,  with  the  possible  exception 
of  a  few  private  banks,  the  oldest  financial 
institution  in  the  country.  It  is  privately  owned 
and  privately  governed.  Its  board  of  directors, 
chosen  by  the  stockholders,  consists  of  twenty- 
four  persons,  a  portion  of  whom  are  practically 
life  members,  being  regularly  reelected  when 
their  terms  of  office  expire.  The  others  usually 
serve  alternate  years  only,  vacancies  being  filled 
by  promising  young  men  selected  from  the  busi- 
ness houses  of  London.  The  oldest  director  is 
regularly  elected  to  the  office  of  governor  of 
the  Bank,  and  the  next  oldest  to  that  of  deputy 
governor,  both  serving  two  years,  the  deputy 
governor  regularly  succeeding  to  the  office  of 
governor,  and  the  ex-governors  forming  the 
life  members  of  the  board  and  constituting  a 
kind  of  advisory  council  to  the  governor,  and 
known  as  the  Board  of  Treasury. 

The  head  office  of  the  Bank  of  England  is  in 
London,  and  there  are  eleven  branches,  two  in 
London  and  nine  in  the  provinces.  By  a  law 
passed  in  1844,  the  Bank  was  divided  into  two 


In  Other  Countries  105 

departments,  called  respectively  the  banking  and 
the  issue  departments,  the  latter  having  exclu- 
sive charge  of  the  issue  of  notes,  and  the  former 
of  all  other  branches  of  the  bank's  business. 

This  same  law  prescribed  the  conditions 
under  which  notes  could  be  issued.  It  provided 
that  the  Bank  of  England  might  issue  £14,500,- 
000  of  notes  in  exchange  for  securities,  and  any 
amount  in  addition  in  exchange  for  an  equal 
amount  of  coin  or  bullion.  Additions  to  the 
amount  issued  in  exchange  for  securities  might 
be  made  by  order  of  the  government  to  the 
extent  of  two-thirds  the  amount  of  issues  relin- 
quished by  the  other  issuing  banks,  all  such 
banks  in  existence  at  the  time  the  act  was  passed 
being  permitted  to  retain,  without  increasing, 
their  existing  issues.  Most  of  these  other  issues 
having  been  abandoned  since  1844,  the  Bank 
of  England  is  now  permitted  to  issue  in 
exchange  for  securities  £18,450,000.  The  secu- 
rities against  which  these  issues  are  made  were 
transferred  to  the  issue  department  by  the  bank- 
ing department,  and  consist  of  the  debt  owed 
by  the  government  to  the  bank  and  of  other 
government  or  governmentally  guaranteed  secu- 
rities. The  issue  department  freely  issues  addi- 
tional notes  in  exchange  for  an  equal  amount 
of  gold  coin  or  bullion,  and  on  demand  redeems 


106  Banking 

notes  in  gold  coin.  Since  the  amount  of 
notes  all  the  time  outstanding  greatly  exceeds 
£18,450,000,  the  business  of  the  issue  depart- 
ment is  confined  to  the  exchange  of  notes  for 
gold  coin  and  bullion  and  the  redemption  of 
notes  in  gold. 

The  banking  department  receives  and  dis- 
burses the  funds  of  the  government,  manages 
the  public  debt,  and  serves  as  the  government's 
agent  in  most  of  its  other  financial  operations; 
receives  on  deposit  from  other  financial  institu- 
tions the  money  which  comes  into  their  posses- 
sion, and  supplies  them  with  such  money  funds 
as  they  need  from  day  to  day  in  payment  of 
checks  drawn  against  their  balances ;  discounts 
bills  of  exchange  with  a  minimum  maturity  of 
four,  and  in  exceptional  cases  six,  months ;  and 
to  a  limited  extent  makes  advances  on  and 
invests  in  high-grade  public  and  other  securi- 
ties. Besides  the  English  government  and  finan- 
cial institutions,  it  has  other  customers,  but  it 
is  to  be  presumed  that  these  are  of  a  special 
character,  since  the  conditions  under  which  it 
does  business  with  private  persons  are  in  most 
cases  more  onerous  than  those  prescribed  by 
other  banks,  and  consequently  not  attractive  to 
the  ordinary  business  man. 

The  so-called  English  Joint-Stock  Banks  are 


In  Other  Countries  107 

classified  into  three  groups,  known  as  metro- 
politan, metropolitan  and  provincial,  and  pro- 
vincial banks.  The  metropolitan  banks  have 
their  head  offices  in  London,  and  do  not,  as  a 
rule,  extend  their  branches  beyond  the  suburbs 
of  the  metropolis.  The  metropolitan  and'  pro- 
vincial banks  have  their  head  offices  in  London 
and  branches  scattered  throughout  the  prov- 
inces, as  well  as  in  various  parts  of  the  city  and 
suburbs,  and  the  provincial  banks  have  their 
head  offices  in  the  larger  provincial  cities,  and 
each  one  confines  its  branches  usually  to  the 
town  and  country  districts  tributary  to  the  city 
in  which  its  head  office  is  situated.  Often  the 
provincial  banks  establish  branches  in  London. 
For  banking  purposes,  these  banks  are  the 
chief  reliance  of  the  agriculture,  industry,  and 
commerce  of  the  country,  but  competing  with 
and  supplementing  them  are  the  bill  brokers 
and  discount  houses,  the  private  banks,  and  the 
foreign  and  colonial  banks.  The  bill  brokers  and 
discount  houses  make  a  business  of  dealing  in 
foreign  and  domestic  bills  of  exchange.  They 
buy  in  the  first  instance  a  large  percentage  of 
the  bills  brought  to  market,  keep  some  of  them 
until  maturity,  and  sell  the  remainder  to  the 
other  banks,  usually  indorsing  them  first.  A 
large  part  of  the  capital  employed  in  their  busi- 


1 08  Banking 

ness  is  obtained  by  loans  made  from  the  other 
banks,  subject  to  call  and  secured  by  the  bills 
they  purchase  deposited  as  collateral. 

The  private  banks  are  the  remnant  left  of  the 
oldest  group  in  the  country.  There  were  pri- 
vate banks  in  London  centuries  before  the  Bank 
of  England  was  incorporated,  and  previous  to 
1826  the  Bank  of  England  was  their  only  com- 
petitor. Since  1844  their  number  has  steadily 
diminished.  Those  which  remain  have,  as  a 
rule,  built  up  a  special  constituency,  to  the  spe- 
cial interests  of  which  they  cater.  Among  them 
are  strong  institutions,  but  as  a  class  their  impor- 
tance in  the  system  is  not  great,  and  is  waning. 

The  foreign  and  colonial  banks  are  branches 
of  important  institutions  in  foreign  countries 
and  the  English  colonies  which  have  a  consid- 
erable volume  of  business  to  transact  in  Lon- 
don. They  serve  as  intermediaries  between  their 
respective  countries  and  the  English  money 
market,  and  on  account  of  the  enormous  volume 
of  foreign  commerce  which  is  financed  in  Lon- 
don, their  number  is  large,  and  the  role  they 
play  on  that  market  is  important. 

In  the  operation  of  this  machinery,  the  most 
noteworthy  features  are  the  reserve  system, 
and  the  administration  of  the  discount  rate  of 
the  Bank  of  England.     There  is  no  law  on  the 


In  Other  Countries  109 

English  statute  books  prescribing  the  amount 
of  cash  which  banking  or  other  financial  insti- 
tutions shall  keep  in  their  vaults.  The  custom 
of  these  institutions  regarding  that  matter  is 
to  keep  on  hand  relatively  small  sums  and  to 
rely  upon  the  Bank  of  England  or  some  other 
London  banking  house  for  the  replenishment 
of  their  supply  as  needed.  For  this  purpose, 
London  and  many  provincial  banks  keep  bal- 
ances with  the  Bank  of  England,  and  other 
banks  maintain  balances  with  other  London 
institutions.  These  balances  may  be  obtained 
by  the  deposit  of  coin  or  Bank  of  England 
notes  or  by  rediscounts.  Another  widely  used 
resource  is  the  calling  of  loans  made  to  bill 
brokers  or  discount  houses.  Such  loans  or  a 
considerable  volume  of  bills  of  the  kind  dis- 
counted by  the  Bank  of  England,  or  both,  are 
regularly  carried  by  London  banks  and  counted 
as  a  part  of  their  reserves. 

On  account  of  these  practices,  surplus  cash 
not  needed  in  the  conduct  of  the  current  busi- 
ness of  the  country  speedily  finds  its  way  into 
the  vaults  of  the  Bank  of  England,  and  addi- 
tional supplies,  when  needed,  come  from  this 
source.  The  administration  of  the  cash  reserves 
of  the  country  thus  becomes  one  of  the  impor- 
tant duties  of  the  Bank  of  England,  in  the 


no  Banking 

performance  of  which  variation  of  the  rate 
charged  on  discounts  is  the  most  important 
device. 

Many  years'  experience  has  enabled  the  Bank 
to  determine  with  a  considerable  degree  of  accu- 
racy the  volume  of  the  demands  for  cash  likely 
to  be  made  upon  it  from  day  to  day,  and  con- 
sequently the  amount  that  it  should  keep  on 
hand  in  the  vaults.  Whenever  this  amount 
approaches  the  minimum  regarded  as  consistent 
with  safety,  the  directors  raise  the  rate  of  dis- 
count, and  when  the  amount  on  hand  becomes 
excessive,  they  lower  it.  The  efficiency  of  this 
procedure  in  increasing  the  reserves  in  the  one 
case  and  in  decreasing  them  in  the  other  is 
due  to  certain  conditions  and  practices  which 
deserve  attention  at  this  point. 

Long-established  custom  has  made  the  rate 
of  interest  paid  on  deposits  in  London  and  other 
parts  of  England  vary  with  the  discount  rate  of 
the  Bank,  and  on  this  account  the  market  rate 
of  discount  also  varies  in  the  same  manner. 
The  Bank  of  England  is  thus  ordinarily  able  to 
regulate  the  market  for  commercial  paper.  Since 
paper  payable  in  London  is  a  favorite  form  of 
investment  for  continental  bankers,  by  raising 
its  rate  of  discount  and  with  it  the  market  rate 
above  the  level  of  the  rates  of  some  or  all  of 


In  Other  Countries  in 

the  continental  centers,  the  Bank  of  England 
is  able  to  induce  these  bankers  to  send  money  to 
London  for  investment  -and  thereby  to  increase 
her  reserves,  and  by  lowering  its  rate  below  the 
level  of  the  rates  in  these  continental  centers, 
she  is  able  to  induce  them  to  sell  some  of  the 
paper  they  already  hold,  and  thus  to  furnish  a 
market  for  her  surplus  funds  and  diminish  her 
reserves. 

On  account  of  the  readiness  with  which  the 
international  gold  movement  responds  to  varia- 
tions in  the  discount  rate  of  the  Bank  of  Eng- 
land, the  need  for  an  elastic  system  of  bank 
note  issues  is  not  felt  in  England  to  the  same 
extent  as  in  other  countries.  It  is  this  fact, 
doubtless,  which  explains  the  retention  to  the 
present  day  of  the  essentially  inelastic  bank 
note  system  created  by  the  act  of  1844. 

j.  The  French  System 

In  France,  the  Bank  of  France  is  the  central 
institution.  It  is  the  oldest  of  the  important 
French  banks  of  the  present  day,  having  been 
established  in  1S00  by  Napoleon  the  First. 
Its  capital,  amounting  at  the  present  time  to 
182,500,000  francs,  or  approximately  $36,- 
500,000,  is  supplied  by  about  30,000  private 


112  Banking 

stockholders,  about  10,000  of  whom  own  only- 
one  share  each. 

The  two  hundred  largest  stockholders  appoint 
a  General  Council,  consisting  of  fifteen  regents 
and  three  censors.  Five  regents  and  all  the 
censors  must  be  chosen  from  the  commercial 
and  industrial  classes,  and  three  of  the  remain- 
ing ten  regents  must  be  selected  from  the  treso- 
riers  payeurs  gcnercaux,  an  important  group  of 
representatives  of  the  public  treasury  scattered 
throughout  the  country.  The  General  Council 
as  well  as  the  stockholders'  assembly  is  presided 
over  by  a  governor,  who,  together  with  two 
sub-governors,  is  appointed  by  the  President  of 
the  Republic  upon  the  nomination  of  the  Min- 
ister of  Finance.  The  governor  is  the  chief 
executive  officer  of  the  bank  and  the  final  source 
of  authority  in  most  matters  6f  vital  impor- 
tance. He  is  responsible  to  the  government 
rather  than  to  the  stockholders,  and  is  subject 
to  removal  only  by  the  power  which  appointed 
him. 

The  Bank  of  France  has  about  two  hundred 
branches  and  sub-branches  located  in  Paris  and 
all  the  important  cities  and  towns  in  the  Repub- 
lic, also  over  three  hundred  so-called  agencies 
located  in  smaller  places  and  transacting  only 
a  limited  line  of  business.     Each  branch  has  a 


In  Other  Countries  113 

manager  appointed  in  substantially  the  same 
manner  as  the  governor,  and  the  sub-branches 
and  agencies  are  administered  through  the 
branches.  Through  this  network  of  offices, 
every  part  of  the  country  is  brought  into  direct 
and  easy  access  to  the  Bank. 

The  Bank  of  France  is  the  only  institution  in 
the  country  privileged  to  issue  circulating  notes. 
The  maximum  allowed  it  is  regulated  by  law 
and  is  increased  from  time  to  time.  At  present 
it  amounts  to  5,800,000,000  francs,  or  approxi- 
mately $1,160,000,000.  The  bank  is  obliged  to 
redeem  these  notes  on  demand  in  gold  coin  or 
silver  five-franc  pieces,  but  it  is  free  to  deter- 
mine how  much  cash  it  shall  keep  on  hand 
for  that  purpose,  and  when  and  under  what 
conditions  it  shall  issue  them. 

Its  discount  operations  are  limited  by  law  to 
bills  maturing  in  not  more  than  three  months, 
and  bearing  the  signatures  of  at  least  three 
solvent  persons,  or  two  signatures  and  secured 
in  addition  by  specified  forms  of  collateral.  It 
is  also  permitted  to  make  loans  or  advances,  as 
they  are  called,  on  securities  of  the  French 
government  maturing  at  fixed  dates,  gold  and 
silver  bullion,  and  the  money  of  foreign  coun- 
tries, and  obligations  of  the  French  railroads, 
French    cities,   and    departments,    the   Credit 


H4  Banking 

Foncier,  and  the  Societe  Algerienne.  It  is  also 
obliged  to  loan  180,000,000  francs  ($36,000,- 
000)  to  the  government  without  interest. 

One  of  the  chief  branches  of  the  business  of 
the  Bank  of  France  is  the  service  of  the  public 
treasury  and  the  performance  of  other  finan- 
cial duties  imposed  upon  it  by  the  government. 
It  serves  as  the  depository  and  disbursing  agent 
for  the  government,  and  performs  important 
functions  connected  with  the  public  debt,  the 
mints,  the  savings  institutions,  and  publicly 
administered  trusts  of  various  kinds.  It  is  also 
the  depository  for  the  banking  reserves  of  the 
country.  In  France,  as  in  England,  it  is  not  the 
custom  of  banking  and  other  financial  institu- 
tions to  hoard  money  in  their  vaults,  but  to 
depend  upon  the  Bank  of  France  for  supplies 
as  needed.  To  this  end  they  keep  funds  on 
deposit  there,  and  regularly  rediscount  the  paper 
of  their  customers  when  balances  need  to  be 
replenished. 

Through  its  network  of  branches  and  agen- 
cies spread  over  the  entire  country,  the  Bank 
of  France  is  able  economically  and  expeditiously 
to  conduct  the  intcrmunicipal  exchanges  of 
the  country.  It  participates  in  local  clearings 
through  membership  in  the  clearing  houses,  at 
which  balances  are  paid  by  checks  drawn  against 


In  Other  Countries  115 

credits  on  its  books  maintained  for  that  pur- 
pose by  all  members,  and  it  conducts  so-called 
transfer  accounts  with  other  banks  and  financial 
institutions  against  which  drafts  can  be  drawn 
payable  at  any  place  where  one  of  its  offices  is 
located.  Such  drafts  constitute  the  chief  means 
through  which  transfers  of  funds  are  made 
between  different  places. 

The  business  of  the  Bank  of  France  with 
private  persons  is  limited  by  the  requirement 
that  all  paper  discounted  must  have  three  sig- 
natures, or  two  signatures  and  collateral  secu- 
rity, and  that  advances  can  only  be  made  on 
the  security  of  the  forms  of  collateral  indicated 
above.  Most  business  men  find  it  either  incon- 
venient or  impossible  to  comply  with  these 
conditions,  and  consequently  transact  most  of 
their  business  with  other  banking  institutions. 
The  third  signature  on  paper  discounted  by  the 
Bank  is,  therefore,  usually  supplied  by  these 
institutions,  which  thus  act  as  an  intermediary 
between  the  Bank  and  the  commercial  world. 

Next  to  the  Bank  of  France,  the  most  impor- 
tant banking  institutions  of  the  country  are  the 
Credit  Foncier,  the  Credit  Lyonnais,  the  Comp- 
toir  d'Escompte  de  Paris,  the  Societe  Generale, 
and  the  Credit  Industrielleet  Commercial.  The 
Credit  Foncier  is  principally  engaged  in  extend- 


n6  Banking 

ing  credit  based  on  real  estate  security,  but  it 
also  discounts  large  amounts  of  commercial 
paper.  Its  organization  is  modeled  after  that 
of  the  Bank  of  France,  and,  like  that  institu- 
tion, it  is  controlled  by  the  state.  Since  it  is 
primarily  an  investment  bank,  a  description  of 
its  principal  operations  will  be  deferred  to  the 
next  chapter. 

The  four  other  banks  mentioned  are  a  prod- 
uct of  the  commercial  life  of  modern  France, 
all  having  been  established  since  the  revo- 
lution of  1848.  They  are  all  heavily  capi- 
talized, the  smallest,  the  Credit  Industrielle  et 
Commercial,  having  a  capital  of  100,000,000 
francs  ($20,000,000),  and  the  largest,  the 
Societe  Generale,  having  a  capital  of  400,000,- 
000  francs  ($80,000,000),  and  all  extend  their 
business  by  means  of  branches.  The  Credit 
Lyonnais  and  the  Comptoir  d'Escompte  have 
branches  in  France  itself,  the  French  colonies, 
and  a  number  of  foreign  countries;  the  Societe 
Generale,  throughout  France,  in  London,  and 
San  Sebastian,  Spain ;  and  the  Credit  Indus- 
trielle et  Commercial,  in  Paris  and  its  suburbs. 
Taken  together,  these  four  institutions  supply 
the  French  people  in  Paris  and  the  Provinces 
with  banking  facilities  for  both  their  domestic 
and  their  foreign  business.     While  in  some  of 


In  Other  Countries  117 

the  larger  provincial  cities  local  banks  with 
branches  in  surrounding  towns  and  sometimes 
in  Paris  are  to  be  found,  branches  of  one  or 
more  of  these  four  institutions  are  the  chief 
reliance  in  nearly  all  places. 

These  institutions  cater  to  all  the  financial 
needs  of  their  constituents.  They  supply  their 
needs  for  cash  and  for  exchange;  conduct 
checking  accounts  for  them,  although  these  are 
not  used  in  France  to  the  same  extent  as  in  the 
United  States;  discount  their  commercial  paper 
and  make  loans  to  them  on  personal  and  other 
security;  and  receive  on  deposit  their  savings 
and  provide  them  with  investments.  In  per- 
forming these  functions  they  make  extensive 
use  of  the  Bank  of  France  and  of  the  stock 
exchanges  of  the  country.  With  the  former 
they  conduct  checking  and  transfer  accounts 
and  rediscount  their  customers'  bills,  by  these 
means  procuring  the  coin,  bank  notes,  and 
exchange  needed;  and  from  the  latter  they 
obtain  the  investment  securities  required  for 
the  satisfaction  of  both  their  own  and  their 
customers'  needs. 

Gold  and  silver  coin  and  the  notes  of  the 
Bank  of  France  constitute  the  hand-to-hand 
money  of  the  country.  The  latter  form  the  elas- 
tic element,  and  their  operation  approximates 


1 1 8  Banking 

perfection.  When  demand  for  money  increases 
for  any  reason,  more  commercial  bills  are  pre- 
sented for  discount  to  the  banks,  which,  after 
indorsement,  exchange  them  at  the  Bank  of 
France  for  the  notes  with  which  they  supply 
their  customers'  needs.  The  note  issues  of  the 
Bank  thus  expand  in  direct  and  immediate 
response  to  the  needs  of  the  country  for  more 
currency.  When  such  needs  have  passed,  the 
discounted  bills,  in  exchange  for  which  these 
notes  were  issued,  mature  and  are  paid  in 
greater  volume  than  new  bills  are  created  and 
presented  for  discount,  and  notes,  or  a  corre- 
sponding amount  of  coin,  accumulate  in  the 
vaults  of  the  Bank.  The  notes  are  cancelled 
and  destroyed  and  the  coin  is  kept  in  store 
until  it  again  passes  into  circulation  through 
exchange  for  notes  still  outstanding,  or  for 
discounted  bills. 

On  account  of  the  elasticity  of  its  note  issues, 
and  the  extent  to  which  they  are  used  in  the 
commerce  of  the  country,  the  Bank  of  France 
has  occasion  to  change  its  rate  of  discount  less 
frequently  than  any  other  bank  in  Europe.  The 
result  is  that  the  country  enjoys  the  advantage 
of  steady  and  low  rates,  since  in  France,  as  in 
England,  the  discount  rate  of  the  central  bank 
controls  the  market  rate,  and  the  ease  and  inex- 


In  Other  Countries  119 

pensiveness   with  which  the   notes  are  issued 
make  low  rates  possible. 

4.  The  German  System 

The  Imperial  Bank,  with  head  offices  in  Ber- 
lin, and  about  one  hundred  branches  and 
more  than  four  hundred  sub-branches  scattered 
throughout  the  country,  plays  essentially  the 
same  role  in  the  German  banking  system  that 
the  Bank  of  England  and  the  Bank  of  France 
play  in  the  English  and  French  systems,  respec- 
tively. It  was  established  in  1875  by  an  act 
which  also  profoundly  affected  the  entire  bank- 
ing system  of  the  country,  and  its  development 
has  been  aided  and  directed  by  several  acts 
passed  subsequently. 

Its  capital,  supplied  by  the  general  public, 
amounts  at  the  present  time  to  180,000.000 
marks  ($45,000,000),  and  it  is  governed  by 
three  boards,  known  respectively  as  the  Cura- 
torium,  the  Direktorium,  and  the  Central  Aus- 
schuss. 

The  Curator ium  is  composed  of  five  mem- 
bers, of  which  body  the  Chancellor  of  the 
Empire  is  ex-officio  chairman.  A  second  mem- 
ber is  apoointed  by  the  Emperor,  and  for  that 
position  he  has  always  selected  the  Prussian 


120  Banking 

Minister  of  Finance,  and  the  three  remaining 
members  are  appointed  by  the  Bundesrath.  It 
meets  quarterly  and  reviews  all  the  operations 
of  the  bank.  It,  or  rather,  the  Chancellor,  its 
chairman,  has  supreme  power,  which,  how- 
ever, he  has  never  exercised  except  on  one 
occasion,  when  he  ordered  the  bank  not  to 
accept  Russian  securities  as  collateral  for  loans, 
an  order  since  revoked. 

The  administration  of  the  bank's  affairs  is 
chiefly  in  the  hands  of  the  Direktorium,  con- 
sisting of  a  president,  vice  president,  and  seven 
other  persons,  all  of  whom  are  appointed  by 
the  Emperor  for  life,  from  a  list  of  candidates 
recommended  to  him  by  the  Bundesrath.  This 
board  selects  the  staff  of  bank  officers  and 
clerks,  and  superintends  the  daily  conduct  of 
the  bank's  business. 

The  Central  Ausschuss  is  a  committee  of 
fifteen  persons  elected  by  and  representing  the 
stockholders.  It  holds  monthly  meetings;  has 
the  right  to  demand  complete  information  con- 
cerning the  bank's  operations,  to  discuss  all 
matters  freely,  and  to  tender  advice  and  coun- 
sel ;  but  it  has  no  power  to  control  except  regard- 
ing two  matters:  it  can  set  a  limit  to  the 
amount  of  securities  the  bank  can  purchase, 
and  can  veto  any  proposed  transactions  with 


In  Other  Countries  121 

the  Imperial  Government  or  with  the  govern- 
ments of  any  of  the  states. 

Like  the  other  central  banks  described  above, 
it  receives  on  deposit  and  disburses  the  funds 
of  the  Imperial  Government;  administers  the 
coin  reserves  of  the  country;  conducts  the 
domestic  exchanges,  and  serves  as  a  bankers' 
bank.  It  is  free  to  do  business  with  the  general 
public,  but  the  legal  and  other  limitations  under 
which  it  must  operate  give  the  other  banking 
institutions  of  the  country  the  advantage  in 
competition  for  this  kind  of  business. 

It  shares  the  right  of  note  issue  with  four 
other  banks,  which,  out  of  thirty-two  that 
retained  that  privilege  at  the  time  the  Imperial 
banking  system  was  established,  alone  retain  it 
at  the  present  time.  The  issues  of  these  four 
institutions,  however,  are  relatively  small  in 
volume,  and  the  Imperial  Government  has  the 
right  to  deprive  them  of  it  January  1,  1921,  or 
any  tenth  year  thereafter,  on  condition  of  giv- 
ing one  year's  notice  of  its  intention  so  to  do. 
The  issues  of  the  Imperial  Bank  are  subject  to 
the  following  regulations :  they  must  be  cov- 
ered by  cash  and  discounted  bills  maturing  in 
not  more  than  three  months,  and  signed  by  at 
least  two  solvent  persons,  the  proportion  of 
cash  being  not  less  than  one-third  of  the  total. 


122  Banking 

If  the  total  amount  issued  exceeds  the  Bank's 
holdings  of  gold  bullion,  specie,  and  govern- 
ment notes  by  more  than  750,000,000  marks 
at  the  end  of  March,  June,  September,  and 
December,  and  555,000,000  marks  at  other 
times,  a  tax  of  five  per  cent  per  annum  is  levied 
on  the  excess. 

The  law  confers  upon  the  Bank  the  follow- 
ing powers : 

a.  To  buy  and  sell  gold  and  silver  coin  and 
bullion. 

b.  To  discount,  buy  and  sell  bills  of  exchange 
whose  maturity  shall  be  three  months  at  the  longest, 
and  for  which  usually  three,  and  in  no  case  less 
than  two,  accredited  vouchers  shall  stand  good ; 
furthermore,  to  discount,  buy  and  sell  bonds  of  the 
Empire  or  of  any  German  state,  or  domestic  munici- 
pal corporations,  provided  such  bonds  mature  within 
three  months  at  the  longest  and  conform  to  the  new 
standards  of  value. 

c.  To  grant  interest-bearing  loans  for  terms  no 
longer  than  three  months,  upon  movable  security 
(lombard,  or  deposit  loan  business),  such  as:  gold 
and  silver,  coined  or  uncoined ;  interest-bearing  or 
non-transferable  bonds  maturing  within  a  maximum 
term  of  three  months,  whether  of  the  Empire,  a 
German  state,  or  of  domestic  municipal  corpora- 
tions; ..interest-bearing  non-transferable  bonds  on 
which  the  interest  is  guaranteed  by  the  Empire  or 
by  any  one  of  the  German  states ;  capital  stock 
and  stock  priority  shares,  fully  paid  up,  of  German 


In  Other  Countries  123 

railway  companies  in  actual  operation;  mortgage 
bonds  of  the  provincial,  municipal,  or  other  land 
credit  institutions  of  Germany  that  are  subject  to 
state  control,  including  shares  of  German  mortgage 
banks  to  an  amount  never  exceeding  three-fourths 
of  their  market  value;  interest-bearing  non-trans- 
ferable bonds  of  foreign  states,  and  foreign  railway 
priority  bonds,  covered  by  state  security,  in  amounts 
not  exceeding  50  per  cent  of  their  market  value; 
bills  of  exchange  of  recognized  soundness,  after  de- 
ducting at  least  5  per  cent  of  their  market  value; 
and  pledges  of  native  merchandise,  in  amounts 
within  two-thirds  of  their  value. 

d.  To  negotiate  collections  for  the  account  of 
individuals,  institutions,  and  governing  boards;  and 
upon  security,  as  before  mentioned,  to  furnish  pay- 
ments, and  make  orders  or  conveyances  on  the 
branch  banks  or  on  correspondents. 

e.  Upon  prior  security,  to  buy  on  behalf  of  out- 
side parties,  effects  of  all  kinds,  including  the 
precious  metals ;  and  after  delivery  to  sell  the  same. 

f.  To  receive  money  for  circulation  or  on  deposit, 
with  or  without  interest,  the  sum  of  interest-bearing 
deposits  not  to  exceed  that  of  the  capital  stock  and 
reserve  fund. 

g.  To  accept  the  custody  or  other  management 
of  objects  of  value. 

Besides  the  Imperial  Bank  there  are  in  Ger- 
many eight  very  large  and  powerful  banking 
institutions  and  a  considerable  number  of 
smaller   and   less   powerful   ones.     The   eight 


124  Banking 

great  ones  have  each  its  head  office  in  Berlin, 
and  connections,  through  branches,  agencies, 
and  controlled  institutions,  in  other  parts  of  the 
Empire,  the  German  colonies,  and  foreign  coun- 
tries. Together  they  control  about  eighty  per 
cent  of  the  entire  banking  capital  of  the 
Empire.  In  reality  they  are  federations  of 
banking  institutions,  many  of  which  were  once 
independent,  and  some  of  which  were  promoted 
and  established  in  the  interests  of  the  group. 

While  these  eight  institutions  are  primarily 
engaged  in  commercial  banking,  they  are  also 
promoters  on  a  large  scale  of  German  industry 
and  commerce,  both  at  home  and  abroad. 
Through  interlocking  directorates,  stock  owner- 
ship, and  in  other  ways,  they  are  closely  allied 
with  the  leading  industrial  and  transportation 
interests  of  the  Empire,  and  they  have  been 
and  are  leaders  in  the  promotion  of  these  inter- 
ests in  other  parts  of  the  world,  notably  in  the 
Orient,  South  America,  and  Africa.  They  are, 
therefore,  leaders  on  the  stock  as  well  as  the 
discount  markets  of  the  country,  and  are  widely 
influential  in  investment  as  well  as  commercial 
banking  affairs. 

These,  as  well  as  the  other  commercial  banks, 
consisting  for  the  most  part  of  local  institu- 
tions and  those  catering  to  special  interests,  use 


In  Other  Countries  125 

the  Imperial  Bank  for  rediscounts,  for  trans- 
fers of  funds  between  different  parts  of  the 
country,  and  as  a  depository  for  surplus  funds. 
They  do  not  normally  keep  on  hand  more  cash 
than  is  needed  for  till  purposes.  Being  in  easy 
reach  of  an  office  of  the  Imperial  Bank,  supplies 
can  be  obtained  at  any  time  by  checks  drawn 
against  credit  balances  or  through  redis- 
counts of  commercial  bills.  Special  accounts 
are  carried  for  transfer  purposes  and  are  used 
even  in  the  transfer  of  funds  between  different 
offices  of  the  same  institution. 

On  account  of  its  right  to  issue  notes  against 
commercial  securities,  the  Imperial  Bank  has 
the  power  to  meet  the  demands  made  upon  it 
and  to  supply  the  country  with  an  elastic 
medium  of  exchange.  The  levy  of  a  tax  upon 
the  excess  of  the  issues  above  a  prescribed 
maximum  prevents  perfect  elasticity,  unless  this 
maximum  be  kept  above  the  highest  point  which 
the  circulation  would  normally  reach,  since  the 
actual  levy  of  the  tax  forces  the  rate  of  dis- 
count to  such  a  point  as  to  seriously  restrict 
commercial  operations.  However,  since  the  line 
between  commercial  and  investment  banking  is 
not  drawn  by  the  great  Berlin  banks  with  the 
care  that  is  desirable,  and  since  they  have 
been  able  at  times,   especially  on  account  of 


126  Banking 

their  foreign  connections,  to  embarrass  the 
Imperial  Bank  in  its  efforts  to  maintain  ade- 
quate specie  reserves,  such  a  tax  is  probably  a 
desirable  safeguard  against  over-expansion  of 
credit. 

5.  The  Canadian  System 

In  important  respects  the  Canadian  banking 
system  differs  from  those  of  the  European  coun- 
tries which  have  been  described  and  from  that 
of  the  United  States.  It  consists  of  a  varying 
number  of  relatively  large  institutions,  each 
with  several  offices  administered  from  a  com- 
mon center,  but  without  a  central  bank.  For 
some  time  the  total  number  has  decreased,  since 
1900  from  thirty-six  to  twenty-seven,  in  spite 
of  the  fact  that  the  Canadian  law,  like  that  of 
the  United  States,  provides  for  the  formation 
of  new  banks  at  any  time,  on  compliance  with 
certain  prescribed  ^conditions,  including  a  sub- 
scribed capital  of  at  least  $500,000  and  a 
paid-up  capital  of  at  least  $250,000.  The  num- 
ber of  branches,  however,  has  increased  rap- 
idly, much  more  rapidly  than  the  population. 

The  most  noteworthy  legal  provisions  per- 
taining to  the  banking  business  in  Canada 
concern  note  issues  and  loans  and  discounts. 
Regarding  the  establishment  of  branches,  the 


In  Other  Countries  127 

amount,  and,  with  one  exception,  the  composi- 
tion of  the  reserves,  and  many  other  matters 
carefully  regulated  by  law  in  the  United  States, 
Canadian  bankers  are  left  free  to  follow  their 
own  judgment.  Neither  is  there  public  exami- 
nation of  banks  in  Canada.  Reports  must  be 
regularly  made  to  the  Minister  of  Finance,  and 
he  may  call  for  special  reports  whenever  he 
desires  so  to  do;  but  neither  he  nor  any  other 
public  officer  has  the  right  to  examine  a  bank's 
books  or  to  quiz  its  officers  or  directors.  In 
contrast  with  banking  legislation  in  the  United 
States,  another  peculiar  feature  of  Canadian 
law  is  the  incorporation  of  the  Canadian  Bank- 
ers' Association,  an  organization  resembling  in 
essentials  the  American  Bankers'  Association, 
and  the  assignment  to  it  of  important  functions 
connected  with  the  issue  of  notes  and  the 
winding  up  of  the  affairs  of  failed  banks. 

Regarding  note  issues,  the  chief  provisions 
of  the  Canadian  law  are  as  follows :  Each  bank 
is  permitted  at  any  time  to  issue  circulating 
notes  to  the  amount  of  its  capital  stock,  and 
between  October  1  and  January  1  an  additional 
amount,  equal  to  fifteen  per  cent  of  its  com- 
bined capital  and  surplus,  may  be  issued  on  pay- 
ment of  a  tax  to  be  assessed  by  the  Governor  in 
Council,  not  to  exceed  five  per  cent  per  annum. 


128  Banking 

The  notes  are  a  first  Hen  on  all  the  assets  of 
the  bank  that  issued  them,  and  must  be  redeemed 
on  demand  at  the  head  office  and  at  such  other 
places  as  are  designated  by  a  committee  of  pub- 
lic officials  known  as  the  Treasury  Board.  As 
such  redemption  centers,  this  board  has  named 
Toronto,  Montreal,  Halifax,  Winnipeg,  Vic- 
toria, St.  John,  and  Charlottetown.  Each  bank 
must  also  deposit  with  the  Minister  of  Finance 
a  sum  of  money  equal  to  five  per  cent  of  its 
average  circulation.  The  aggregate  of  the 
amounts  thus  deposited  by  all  the  banks  is 
known  as  the  "circulation  redemption  fund," 
and  may  be  used  in  the  redemption  of  the  notes 
of  a  failed  bank.  In  case  the  fund  is  so  used, 
and  the  liquidated  assets  of  the  bank  prove  to 
be  inadequate  for  its  complete  replenishment,  a 
tax  sufficient  to  meet  the  deficit  is  levied  on  the 
solvent  banks  in  proportion  to  their  circulation. 
Regarding  loans  and  discounts,  the  law  aims 
rather  to  protect  than  to  restrict  the  operations 
of  the  banks.  They  may  "  deal  in,  discount, 
and  lend  money,  and  make  advances  upon  the 
security  of,  and  may  take  as  collateral  security 
for  any  loans,  .  .  .  bills  of  exchange,  promis- 
sory notes,  and  other  negotiable  securities,  or 
the  stocks,  bonds,  debentures,  and  obligations 
of  municipal  and  other  corporations,  whether 


In  Other  Countries  129 

secured  by  mortgage  or  otherwise,  or  Dominion, 
provincial,  British,  foreign,  and  other  public 
securities."  The  only  important  restriction 
placed  upon  their  loaning  activities  is  the  pro- 
hibition of  making  advances  on  the  security 
of  landed  or  other  immovable  property. 

In  making  loans  to  wholesale  dealers  and 
shippers  of  produce,  the  law  safeguards  the 
banks  by  allowing  them  to  take  a  blanket  lien 
on  the  goods  dealt  in  by  the  borrower.  This 
lien  applies  not  only  to  the  goods  in  possession 
at  the  date  of  making  the  loan,  but  to  any 
others  which  may  be  substituted  for  them  or 
manufactured  out  of  them.  This  lien  is  prior 
to  that  of  any  other  unpaid  vendor,  except  one 
acquired  before  the  bank's  lien  was  established. 

The  chief  officers  of  a  Canadian  bank  are 
the  general  manager,  the  chief  accountant,  the 
superintendent  of  branches,  the  inspector,  and 
the  secretary,  all  connected  with  the  head  office, 
and  the  managers  of  the  branches. 

The  general  manager  is  the  chief  executive 
and  the  chief  in  authority.  While  he  is  subject 
to  the  board  of  directors,  on  account  of  his 
wide  experience  and  knowledge  his  judgment 
is  usually  followed.  The  other  officers  are 
appointed  by  him  with  the  approval  of  the 
board,  but,  almost  without  exception,  from  per- 


130  Banking 

sons  who  have  served  the  bank  in  subordinate 
capacities.  The  general  manager  himself  is 
nearly  always  a  man  who  has  passed  through 
the  hierarchy  of  positions  from  the  bottom  up, 
and  is  therefore  thoroughly  familiar  with  every 
detail  of  the  bank's  business  and  history.  The 
inspector  has  charge  of  the  examination  of  the 
branches,  and  this  work  is  so  carefully  and 
thoroughly  done  that  examination  by  public 
officials  is  not  considered  necessary,  or  regarded 
as  desirable  by  most  Canadian  bankers. 
Regarding  this  matter,  however,  there  are 
differences  of  opinion,  and  changes  in  the  near 
future  are  not  improbable.  The  managers  of 
the  branches  are  in  strict  subordination  to  the 
authority  of  the  general  manager,  though  they 
are  necessarily  allowed  a  large  amount  of  dis- 
cretionary authority  in  matters  pertaining  to 
the  branch  over  which  they  preside.  Unless 
prevented  by  distance,  they  are  in  daily  com- 
munication with  the  head  office  or  with  one 
of  its  representatives. 

In  the  operation  of  the  Canadian  system, 
noteworthy  features  are  the  methods  of  con- 
trolling credits,  of  managing  the  issues  and  the 
reserves,  and  of  securing  unity  or  at  least  har- 
mony of  action.  It  is  the  usual  practice  in 
Canada  for  a  business  man  to  do  all  his  banking 


In  Other  Countries  131 

with  one  institution.  This  practice  is  rendered 
possible  because  most  of  the  banks  are  large 
enough  to  take  proper  care  of  almost  any  busi- 
ness establishment  in  the  Dominion,  and 
because  experience  has  demonstrated  its  wis- 
dom. 

The  banks  compete  vigorously  for  new 
business  but  do  not  attempt  to  attract  one 
anothers'  customers.  Indeed  a  customer  who 
desires  to  change  his  banking  connections  is 
looked  upon  with  suspicion  and  is  subjected  to 
a  very  careful  examination  by  the  bank  that 
is  asked  to  take  him  on,  including  a  careful 
discussion  of  all  the  aspects  of  the  matter  with 
the  bank  he  desires  to  leave.  The  result  of  this 
practice  is  that  a  man's  banker  is  thoroughly 
familiar  with  his  affairs,  especially  his  credit 
relations,  and  at  the  same  time  feels  under  obli- 
gations to  render  him  such  support  and  guid- 
ance as  he  deserves.  On  account  of  this 
practice,  also,  commercial  paper  brokerage 
does  not  flourish  in  Canada. 

The  notes  of  the  Canadian  banks  constitute 
practically  all  of  the  hand-to-hand  money  of 
the  country  in  denominations  above  two  dollars. 
The  one  and  two  dollar  denominations  are  sup- 
plied by  Dominion  notes  —  all  but  $30,000,- 
000  of  which  are  represented  by  gold  coin  or 


132  Banking 

bullion  —  and  the  lower  denominations  by  sub- 
sidiary silver  supplied  by  the  government. 

Each  bank  pays  out  its  notes  freely  to  supply 
the  cash  demands  of  its  customers,  and  receives 
from  them  on  deposit,  without  hesitation  or 
depreciation,  the  notes  of  other  banks  as  well 
as  its  own.  The  former,  however,  are  either 
sent  in  for  redemption  as  soon  as  received  or 
used  in  making  payments  to  the  banks  which 
issued  them.  Thus  notes  are  cleared  as  readily 
as  checks  and  the  volume  in  circulation  expands 
and  contracts  in  automatic  response  to  business 
needs.  The  fact  that  these  notes  are  neither 
legal  tender  nor  guaranteed  by  the  government 
does  not  interfere  with  their  circulation  —  daily 
clearings,  the  first  lien  on  assets,  and  the 
redemption  fund  amply  protecting  holders 
against  the  possibility  of  loss  —  but  does  pre- 
vent their  being  hoarded  as  reserves  or  for  any 
other  purpose  and  thus  contributes  towards 
their  elasticity. 

The  connection  now  established  by  law  be- 
tween the  maximum  volume  of  bank  note 
issues  and  the  capitalization  of  the  banks  ren- 
ders necessary  the  increase  of  the  latter  in  cor- 
respondence with  the  expansion  of  commerce 
in  order  to  prevent  a  contraction  of  credit. 
Present  law,   however,   does   not  provide   for 


In  Other  Countries  133 

such  an  increase.  It  is  left  to  the  voluntary 
action  of  the  banks,  which  seem  inclined  to  in- 
crease surplus  funds  rather  than  capital.  The 
permission  granted  in  1908  to  extend  issues 
beyond  the  amount  of  capital  during  the  crop 
moving  season,  on  payment  of  a  tax,  is  a  make- 
shift and  not  a  solution  of  the  difficulty,  since 
a  tax  on  issues  is  a  means  of  forcing  contrac- 
tion of  credit  and  not  of  adjusting  issues  to 
legitimate  needs. 

Since  Canadian  banks  are  able  to  meet  the 
greater  part  of  the  public  demand  for  hand- 
to-hand  money  by  means  of  their  own  notes, 
they  do  not  need  to  carry  in  their  vaults  large 
amounts  of  gold  and  silver  coin  and  Dominion 
notes.  They  keep  on  hand  only  so  much  as 
experience  indicates  they  are  likely  to  be  called 
upon  to  supply  to  their  customers,  plus  a 
reasonable  margin  for  safety  and  for  the  pay- 
ment of  clearing  house  balances.  The  greater 
part  of  their  reserves  consists  of  balances  in 
banks  outside  of  Canada,  especially  in  the 
United  States  and  England,  call  loans  in  New 
York  City,  and  easily  salable  securities.  In 
case  of  an  emergency  of  any  kind  these  re- 
sources may  be  transformed  into  gold  or  their 
customers  supplied  with  foreign  exchange, 
which  is  often  as  much  or  even  more  needed. 


134  Banking 

Gold  can  at  any  time  be  exchanged  for  Do- 
minion notes  if  that  is  the  currency  wanted. 

The  lack  of  a  central  bank  and  of  a  re- 
discount market  is  to  a  degree  compensated 
by  unity  of  action  among  the  banks.  This  is 
the  result  not  so  much  of  law  as  of  conditions, 
among  which  the  most  important  are:  the  fact 
that  the  six  largest  banks  do  fifty  per  cent  of 
the  business  and  that  one  of  these,  the  Bank  of 
Montreal,  holds  most  of  the  deposits  of  the 
government  and  is  generally  spoken  of  as  the 
government  bank;  the  fact  that  the  general 
managers  are  experts,  in  first-hand  touch 
through  their  branches  with  business  condi- 
tions in  Canada  and  other  parts  of  the  world, 
and  in  possession  of  the  same  data  concern- 
ing these  conditions,  and  through  the  same 
kind  of  acquired  skill  and  similar  experiences 
likely  to  draw  the  same  or  at  least  similar 
conclusions  from  this  data ;  common  interests 
in  the  prosperity  of  the  country  and  in  the 
prevention  of  speculative  excesses  and  mutual 
interdependence  in  the  successful  conduct  of 
their  everyday  business  as  well  as  in  times 
of  emergency  and  stress:  and  the  Bankers' 
Association,  which  through  its  journal  gives 
authoritative  expression  to  the  best  banking 
opinion   and   actually   acts   for   the   banks   in 


In  Other  Countries  135 

many  matters  of  common  interest.  To  what 
extent  this  community  of  action  takes  the 
form  of  rediscounts  for  each  other  in  ordi- 
nary times  it  is  impossible  for  an  outsider 
to  say,  but  that  it  is  operative  in  times  of 
stress  is  indicated  by  the  manner  in  which  the 
failures  of  the  Bank  of  Ontario  in  1906  and 
the  Sovereign  Bank  in  1908  were  handled. 

In  both  of  these  cases  the  public  was  pro- 
tected against  loss  and  panic  was  averted  by 
the  cooperative  action  of  the  other  banks  in 
assuming  the  obligations  of  these  institutions 
to  the  public,  and  in  winding  up  their  affairs  in 
such  a  manner  as  to  occasion  little  disturbance. 

While  Canadian  banks  are  free  to  carry  on 
investment  as  well  as  commercial  banking 
operations,  their  published  reports  indicate  that 
they  take  care  to  avoid  confusion  of  the  two, 
or  the  infringement  of  one  upon  the  other. 
Their  holdings  of  investment  securities  are  kept 
well  within  the  limits  set  by  their  aggregate 
capital,  surplus,  and  savings  funds,  and  their 
method  of  handling  commercial  business,  based 
as  it  is  on  accurate  knowledge  of  their  cus- 
tomer's operations  and  upon  the  lien  upon 
produce  heretofore  described,  prevents  their 
acceptance,  through  ignorance,  of  investment 
securities  under  commercial  disguise. 


CHAPTER  VI 
Investment  Banking 

TN  the  economy  of  nations  the  encouragement 
-*-  and  promotion  of  saving  and  the  accumula- 
tion, distribution,  and  investment  of  capital  are 
as  essential  as  the  conduct  of  exchanges,  but 
the  performance  of  these  functions  has  not  been 
segregated  and  institutionalized  to  the  same 
extent  as  has  commercial  banking.  Vast 
amounts  of  capital  are  invested  directly  by  the 
people  to  whom  it  belongs  without  the  aid  of 
middlemen  and  large  amounts  are  also  invested 
through  brokers  of  one  kind  and  another  who 
can  hardly  be  classed  as  bankers.  The  most 
important  types  of  institutions  which  have 
been  developed  in  connection  with  these  func- 
tions are  savings  banks,  trust  companies,  bond 
houses  and  investment  companies,  land  banks, 
and  stock  exchanges. 

I.  Saving  and  Savings  Institutions 

Saving  is  an  individual  matter  for  which  the 
essential  conditions  are  the  development  of  the 
136 


Investment  Banking  137 

instinct  to  make  provision  against  uncertainties 
of  future  income  and  to  better  the  material 
condition  of  one's  self  and  family,  and  a  sur- 
plus of  income  above  necessary  daily  expendi- 
tures. In  order  to  secure  the  realization  of 
these  conditions  to  as  great  an  extent  as  pos- 
sible, many  agencies  cooperate  in  all  modern 
nations,  among  them  savings  institutions.  In- 
cluded among  these  are  various  forms  of  provi- 
dent associations,  sometimes  independently  or- 
ganized and  sometimes  connected  with  other 
organizations,  insurance  associations  of  many 
kinds,  building  and  loan  societies,  and  savings 
banks. 

The  need  for  savings  institutions  varies 
greatly  among  the  different  nations  and  among 
different  classes  of  people  in  the  same  nation. 
Among  people  of  great  wealth  the  surplus  of 
income  above  expenditures  is  so  great  that  large 
savings  can  hardly  be  avoided,  and  among  all 
the  well-to-do  classes  the  margin  from  which 
savings  are  possible  is  sufficiently  large  and  the 
desire  to  save  sufficiently  great  to  insure  large 
accumulations  of  capital.  Among  these  classes 
there  is  little  or  no  need  for  institutions  de- 
signed primarily  for  the  development  of  the 
saving  instinct.  What  they  need  are  institu- 
tions for  the  safe  keeping,  accumulation,  and 


138  Banking 

investment  of  the  savings  which  they  are  con- 
stantly making.  The  principal  work  of  savings 
institutions,  therefore,  pertains  to  the  classes  of 
people  who  are  not  well-to-do  and  who  need 
encouragement  and  help  in  their  efforts  to  im- 
prove their  material  condition,  if  they  are  so 
inclined,  and  stimulus  to  make  such  efforts,  if 
they  are  not  so  inclined. 

The  means  available  to  savings  institutions 
for  the  accomplishment  of  these  ends  are  the 
urging  of  the  importance  of  saving  upon  the 
attention  of  people  who  do  not  adequately 
appreciate  it,  the  placing  at  their  easy  disposal 
of  facilities  for  making  savings  when  they  have 
the  ability  and  inclination  to  save,  and  the 
application  of  pressure  of  various  kinds  to 
compel  or  induce  saving. 

In  the  application  of  these  means  the 
methods  employed  by  the  various  groups  of 
institutions  mentioned  differ  widely  and  they 
are  efficient  in  different  degrees,  partly  because 
they  have  other  objects  in  view  besides  the  pro- 
motion of  saving  and  partly  because  they  deal 
with  different  classes  of  people.  Savings  banks 
constitute  the  only  group  to  which  the  term 
bank  can  properly  be  applied  and  consequently 
the  only  one  to  which  attention  will  here  be 
given. 


Investment  Banking  139' 

In  a  book  entitled,  Savings  and  Savings 
Institutions,  written  by  Professor  Hamilton  of 
Syracuse  University,  the  following  definition  is 
given :  * 

Savings  banks  are  institutions  established  by 
public  authority,  or  by  private  persons,  in  order  to 
encourage  habits  of  saving  by  affording  special 
security  to  owners  of  deposits,  and  by  the  payment 
of  interest  to  the  full  extent  of  the  net  earnings, 
less  whatever  reserve  the  management  may  deem 
expedient  for  a  safety  fund ;  and  in  furtherance  of 
this  purpose  bank  offices  are  located  at  places  where 
they  are  calculated  to  encourage  savings  among 
those  persons  who  most  need  such  encouragement. 

Professor  Hamilton  classifies  these  institu- 
tions as  trustee,  cooperative,  municipal,  and 
postal  savings  banks.  In  the  first  group  he 
places  institutions  managed  by  boards  of  philan- 
thropically  inclined  persons  who  serve  without 
pay;  in  the  second,  those  managed  coopera- 
tively by  the  people  who  make  use  of  them ;  in 
the  third,  those  established  and  administered  by 
municipalities ;  and  in  the  fourth,  those  con- 
nected with  the  post-office  departments  of  gov- 
ernments. The  strength  of  trustee  savings 
banks  lies  in  the  comparatively  low  costs  of 
their  administration  and  in  the  fact  that  in  their 


*  Pages  161  and  162. 


140  Banking 

investments  they  are  likely  to  enjoy  the  advan- 
tages of  the  judgment  and  enthusiasm  of 
people  skilled  in  the  investment  business;  that 
of  cooperative  savings  banks,  in  their  adapt- 
ability to  the  special  needs  of  their  constituents 
and  in  the  education  which  cooperative  admin- 
istration involves;  and  that  of  municipal,  and 
especially  of  postal  savings  banks,  in  their 
capacity  to  place  their  services  within  the  easy 
reach  of  all  who  need  them  and  in  the  con- 
fidence which  their  public  character  inspires. 

In  the  investment  of  the  funds  intrusted  to 
savings  banks,  safety  and  as  large  returns  as 
are  consistent  with  it,  rather  than  ease  of 
liquidation,  are  the  prime  considerations,  and 
hence  they  usually  take  the  form  of  high  grade 
investment  securities  rather  than  of  commercial 
paper.  Their  deposits  are  usually  subject  to 
withdrawal  only  after  due  notice,  and,  being 
savings  deposits,  their  withdrawal  usually  fol- 
lows only  after  the  lapse  of  a  considerable 
period  of  time. 

The  purpose  of  their  withdrawal  is  fre- 
quently investment  and  this  is  sometimes  made 
through  the  agency  of  the  bank  which  held  the 
deposit  and  may  involve  merely  a  transfer  of 
securities. 

Outside  of  the  New  England  and  middle 


Investment  Banking  141 

states,  savings  banks  were  rare  in  this  country 
previous  to  the  inauguration  of  our  postal  sav- 
ings bank  system  in  191 1.  The  explanation  of 
tl  is  condition  is  doubtless  to  be  found  chiefly 
in  the  wide  extension  of  private,  state,  and 
national  banks,  and  trust  companies,  practically 
all  of  which  conduct  savings  departments  and 
solicit  the  patronage  of  savers.  These  institu- 
tions have  coveted  this  field  and  have  not 
encouraged  the  establishment  of  savings  banks. 
There  is  reason  to  believe,  however,  that  they 
have  not  worked  the  field  as  thoroughly  as  sav- 
ings banks  would  have  done  and  that,  on 
account  of  the  dominance  of  their  other  inter- 
ests, they  are  not  as  well  fitted  as  savings  banks 
to  work  the  field  thoroughly.  Moreover  it  is 
probable  that  they  are  not  able  to  pay  as  high 
a  rate  on  deposits  as  well  conducted  savings 
banks  would  be  able  to  pay.  There  seems, 
therefore,  to  be  room,  and  probably  need,  here 
for  the  development  of  savings  banks  of  some 
at  least,  if  not  all,  of  the  types  above  described. 

2.  Trust  Companies 

Within  a  comparatively  short  period  of  time 
the  trust  company  has  developed  into  an  insti- 
tution   of    prime    importance    in    the    United 


142  Banking 

States.  In  the  beginning  of  its  history  it  was, 
as  its  name  implies,  simply  an  institution  for 
the  administration  of  trusts  of  various  kinds, 
such  as  the  execution  of  wills,  the  guardianship 
of  minors  and  other  dependent  persons,  the 
administration  of  the  estates  of  persons  either 
unable  or  unwilling  to  administer  them  for 
themselves,  and  trusteeship  under  corporate 
mortgages,  especially  those  of  railroads.  In 
the  latter  capacity  they  became  mortgagees  in 
trust  for  bondholders,  registering  the  bonds, 
collecting  the  interest  as  it  became  due,  paying 
the  bonds  at  maturity,  and  in  case  of  default 
taking  the  legal  steps  which  were  necessary  for 
the  protection  of  the  bondholders. 

The  execution  of  these  trusts  involved  in 
most  cases  the  custody  and  investment  of 
funds,  so  that  investment  banking  became  a 
part  of  their  business  almost  from  the  begin- 
ning, and,  in  time,  in  states  in  which  the  laws 
passed  for  their  regulation  did  not  prevent,  they 
added  commercial  banking  to  their  other  func- 
tions. In  some  cases  they  have  also  become 
promoters  of  enterprises,  taking  the  initiative 
in  the  organization  of  corporations  for  various 
industrial  and  commercial  purposes.  In  New 
York  City,  and  in  individual  cases  in  some 
other  large  cities,  the  commercial  end  of  the 


Investment  Banking  143 

business  has  become  the  dominant  one;  in  the 
former  case  on  account  of  the  ability  of  these 
companies,  unrestricted  by  certain  laws  apply- 
ing to  state  and  national  banks,  to  offer  to  com- 
mercial customers  better  terms  than  their 
competitors.  In  most  states,  however,  especially 
in  the  large  cities  in  which  they  chiefly  flourish, 
trust  companies  have  become  primarily  invest- 
ment banking  institutions,  their  other  functions 
being  carried  on  as  side  lines  and  assuming,  of 
course,  in  some  cases  greater  importance  than 
in  others. 

Since  they  are  still  in  the  early  stages  of 
their  development,  the  status  of  trust  companies 
in  the  banking  system  of  the  United  States  is 
not  yet  definitely  determined.  Legislation  con- 
cerning them  varies  considerably  in  different 
states,  as  do  also  their  relations  with  other 
banking  institutions.  The  competitive  char- 
acter of  these  relations  has  resulted  in  some 
cases  in  legislation  which  has  aimed  to  differ- 
entiate and  define  the  various  functions  which 
all  these  institutions  perform,  and  to  prescribe 
the  conditions  under  which  each  one  or  each 
group  must  be  performed,  regardless  of  the 
way  in  which  they  are  combined,  and  in  others, 
in  their  practical  consolidation  with  national  or 


144  Banking 

state  banks,  or  both,  through  community  of 
stock  ownership,  interlocking  directorates,  etc. 
From  the  point  of  view  of  the  convenience 
of  the  public  there  are  advantages  in  the  com- 
bination of  all  the  banking  functions  in  a  single 
institution,  and  the  success  of  trust  companies 
to  some  extent  has  been  due  to  this  cause,  but 
they  have  also  profited  from  the  unequal  com- 
petition which  exemption  from  certain  limita- 
tions imposed  on  state  and  national  banks  has 
enabled  them  to  enjoy.  The  removal  of  the 
conditions  which  result  in  this  unequal  com- 
petition, a  process  already  in  progress  and 
likely  to  continue  to  completion,  will  reveal  the 
strength  of  the  advantages  of  combination 
versus  specialization  of  functions.  Previous  to 
such  a  revelation  it  will  be  impossible  to  deter- 
mine whether  or  not  the  trust  company  form 
of  organization  is  destined  to  become  the  domi- 
nant one. 

5.  Bond  Houses  and  Investment  Companies 

A  large  part  of  the  business  of  investment 
banking  in  the  United  States  is  conducted  by 
corporations  and  firms  organized  for  the  pur- 
pose of  buying  and  selling  investment  securities, 
especially  bonds  and   mortgages.      Rarely,   if 


Investment  Banking  145 

ever,  do  these  concerns  conduct  savings 
accounts.  Ordinarily  they  confine  their  atten- 
tion exclusively  to  the  investment  end  of  the 
business  and  act  in  the  capacity  of  jobbers,  or 
brokers,  or  both. 

Within  the  investment  field  some  of  them 
specialize  closely  and  others  deal  in  a  wide 
range  of  securities.  The  specialties  most  fre- 
quently followed  are  government,  state,  and 
municipal  bonds,  railroad  bonds,  public  service 
securities,  timber  bonds,  irrigation  bonds,  and 
real  estate  mortgages.  Specialization  involves 
the  development  of  expert  knowledge  of  the 
class  of  securities  dealt  in  and  thus  of  special 
serviceableness  to  both  investors  and  the  pro- 
moters of  the  enterprises  or  the  public  bodies 
which  issue  the  securities.  These  specialists 
sometimes  serve  as  middlemen  between  the 
issuers  of  securities  and  other  investment 
banks,  as  well  as  between  them  and  the  real 
owners  of  the  capital  invested,  their  expert 
knowledge  being  of  service  to  the  former  as 
well  as  the  latter. 

Until  recently  there  have  been  few  attempts 
to  regulate  the  operation  of  these  institutions 
by  law,  but  the  fraudulent  practices  of  some 
of  them,  and  the  ignorance  and  weakness  of 
perhaps  the  majority  of  investors,  have  recently 


146  Banking 

created  in  some  quarters  a  strong  public  senti- 
ment in  favor  of  such  regulation.  In  several 
states  legislation  has  resulted,  of  which  the  most 
noteworthy  is  the  so-called  "blue  sky  laws"  of 
Kansas  and  some  other  states. 

In  details  these  laws  differ  widely  from  one 
another,  but  they  are  alike  in  that  they  impose 
upon  some  branch  of  the  state  government  the 
obligation  of  supervising  both  companies  which 
issue  securities  and  those  which  offer  securities 
for  sale.  The  Kansas  law,  the  first  of  this  kind 
passed  in  the  United  States,  has  been  consid- 
ered too  drastic  by  most  of  the  companies  that 
have  attempted  to  operate  under  it,  but  the 
Wisconsin  law,  which  went  into  effect  Octo- 
ber 1,  19 1 3,  is  looked  upon  with  more  favor. 

In  formulating  these  and  other  laws  for  the 
proper  regulation  of  these  concerns,  it  has 
been  found  difficult  to  provide  adequate  pro- 
tection to  the  investing  public  without  unduly 
hampering  the  issue  and  negotiation  of  securi- 
ties, but  this  difficulty  should,  and  in  time 
doubtless  will,  be  overcome.  A  free  and  open 
market  for  bonds,  stocks,  and  other  evidences 
of  indebtedness  is  essential  to  freedom  of  enter- 
prise and  mobility  of  capital,  which  are  in  turn 
essential  to  the  economic  prosperity  of  any 
country.  On  the  other  hand,  investors  undoubt- 


Investment  Banking  147 

edly  need  and  deserve  the  protection  of  the 
state  against  misrepresentation  and  fraud.  It 
is  practically  impossible  for  them  in  many, 
perhaps  in  most,  cases  to  obtain  the  informa- 
tion necessary  for  self-protection.  The  matters 
and  conditions  to  be  dealt  with  in  such  legisla- 
tion are  so  complex  and  subject  to  such  fre- 
quent change  that  laws  are  apt  to  be  imperfect, 
inefficient,  or  obstructive.  It  seems  probable 
that  those  which  do  not  attempt  to  be  specific 
and  detailed,  but  give  wide  powers  and  discre- 
tion to  administrative  boards  or  commissions, 
are  most  likely  to  be  successful. 

4.  Land  Banks 

In  Europe  an  important  group  of  institutions 
has  developed  for  the  supplying  of  agriculture 
and  the  building  industries  with  the  capital 
needed  in  their  operations.  The  greatest  num- 
ber and  variety  of  these  are  in  Germany,  in 
which  their  development  has  been  continuous 
since  the  days  of  Frederick  the  Great. 

In  order  to  assist  in  the  recuperation  of  his 
kingdom  from  the  devastation  caused  by  the 
Seven  Years'  War,  Frederick  caused  the  land 
owners  of  certain  provinces  to  be  organized 
into  associations  called   Landschaften,   which 


148  Banking 

were  authorized  to  issue  mortgage  bonds  on  the 
joint  security  of  the  lands  of  all  the  members 
of  the  association  in  exchange  for  mortgages 
on  the  lands  of  individual  members  who  needed 
funds  for  the  improvement  of  their  estates. 
These  mortgages  were  made  payable  to  the 
association  in  the  form  of  small  annuities,  to 
which  were  added  the  interest  paid  on  the 
bonds  and  an  increment  for  the  payment  of  the 
expenses  of  the  association. 

These  associations  were  governed  by  the 
members  through  a  general  assembly,  repre- 
sentative boards,  and  elected  officers,  and  were 
supervised  by  the  state  and  carefully  regulated 
by  law.  Regulations  were  carefully  worked  out 
pertaining  to  the  ratio  that  the  loan  should 
bear  to  the  value  of  the  estate  mortgaged, 
methods  of  valuation,  ways  and  means  of 
maintaining  an  equilibrium  between  the  bonds 
issued  and  the  mortgages  held,  the  treatment 
of  defaulting  members,  etc.,  etc.  Machinery 
for  the  sale  of  the  mortgage  bonds  delivered 
to  members  was  also  created,  and  in  some  cases 
later  on  these  sales  were  made  directly  by  the 
associations  themselves,  and  cash  paid  to  the 
maker  of  the  mortgages. 

Five  of  these  original  Landschaften  have 
continued    to    the    present    day,    and    others 


Investment  Banking  149 

modeled  after  them  were  subsequently  estab- 
lished. In  1909  in  all  Germany  twenty- five 
were  in  operation,  of  which  eighteen  were  in 
Prussia.  The  newer  ones  have  not  in  all 
respects  followed  their  models.  Unlike  the 
original  five,  membership  in  them  is  not  limited 
to  the  nobility  and  is  not  compulsory;  the 
liability  of  the  members  for  the  payment  of  the 
bonds  issued  has  in  some  cases  been  limited 
to  a  percentage  of  the  total;  the  loans  are 
usually  paid  in  cash;  and  the  bonds  are  sold 
directly  by  the  associations;  but  the  principles 
of  mutual  liability  and  mutual  control  which 
were  basic  in  the  old  organizations  have  not 
been  violated  in  any  case.  Both  old  and  new 
are  organized  in  the  interests  of  borrowers  on 
real  estate  mortgage  security,  and  aim  to  secure 
funds  for  these  on  the  lowest  possible  terms 
and  for  long  periods  of  time,  by  making  the 
security  offered  the  lenders  greater  than  any 
single  borrower  could  supply. 

The  degree  of  their  success  is  indicated  by 
the  fact  that  in  1909  the  amount  of  their  out- 
standing mortgage  loans  amounted  to  nearly  a 
billion  dollars,  and  that  their  mortgage  bonds 
rank  on  the  exchanges  with  Prussian  state 
bonds  and  have  at  times  outranked  them. 

Another  type  of  land  bank  appeared  in  the 


1 50  Banking 

early  part  of  the  nineteenth  century  as  a  result 
of  the  movement  for  the  freeing  of  the  serfs 
and  their  transformation  into  freehold  peasants. 
The  lands  of  these  cultivators  were  burdened 
with  a  variety  of  feudal  dues  and  charges 
which  had  to  be  commuted  before  they  could 
become  freeholds.  In  order  to  facilitate  this 
process  banks  were  established  which  assumed 
the  obligations  of  a  peasant  towards  his  feudal 
superior  in  return  for  a  mortgage  on  his  hold- 
ing, repayable  with  interest  in  the  form  of  an 
annuity,  and  in  amount  equal  to  the  sum  to 
be  paid  to  the  feudal  superior  for  the  total 
extinguishment  of  all  feudal  obligations. 

Some  of  these  banks  were  established  and 
administered  by  states,  provinces,  and  com- 
munes, and  some  by  private  parties.  The  public 
ones  obtained  the  funds  they  needed  partly 
from  subsidies  and  partly  from  the  sale  of 
guaranteed  mortgage  bonds  and  the  private 
ones  wholly  from  the  sale  of  mortgage  bonds. 

The  completion  of  the  work  for  which  these 
banks  were  originally  established  put  an  end  to 
their  development  about  1883,  but  similar  insti- 
tutions have  since  been  established  in  Prussia 
to  assist  colonists  in  the  purchase  and  equip- 
ment of  their  farms,  and  in  central  and  western 
Germany  to  promote  general  agricultural  and 


Investment  Banking  151 

urban  real  estate  operations.  The  colonists 
sent  into  Poland  for  the  Germanization  of  that 
province  were  in  this  way  assisted  by  the  Prus- 
sian government,  and  in  some  parts  of  Ger- 
many the  same  means  have  been  employed  for 
the  purpose  of  aiding  in  the  process  of  breaking 
up  large  estates  into  small  holdings,  in  the  con- 
struction of  dikes,  roads,  and  reservoirs,  and  in 
changing  the  courses  of  streams. 

Next  to  the  Landschaften  the  most  important 
intermediaries  between  capitalists  and  investors 
in  real  estate  in  Germany  are  the  so-called 
Hypothekenaktienbanken,  or  joint-stock  mort- 
gage banks.  These  are  private  corporations, 
capitalized  by  the  sale  of  stock  shares  to  the 
general  public,  and  controlled  by  their  stock- 
holders through  directorates,  like  industrial 
corporations  the  world  over.  Their  business  is 
the  making  of  long-period  loans  on  real  estate 
security,  and  the  funds  thus  employed  are 
obtained  by  the  sale  of  mortgage  bonds  secured 
by  the  real  estate  mortgages  in  which  the  pro- 
ceeds are  invested  and  by  their  own  capital, 
surplus,  and  other  funds. 

They  differ  from  the  Landschaften  in  that 
they  are  not  cooperative  or  mutual  institutions, 
but  strictly  business  enterprises  run  in  the 
interests  of  their  stockholders.     Their  primary 


152  Banking 

aim  is  to  earn  dividends  rather  than  to  secure 
the  lowest  possible  loan  rates  and  other  favor- 
able terms  for  borrowers.  As  a  matter  of  fact 
they  are  forced  by  competition  and  by  the 
principles  of  good  business  to  make  loans  at 
reasonable  rates  and  on  favorable  terms  regard- 
ing repayment  and  other  matters,  and  they 
successfully  compete  with  the  Landschaften 
and  other  cooperative  credit  institutions  of  Ger- 
many. Their  mortgage  loans  are  usually  made 
repayable  on  the  annuity  plan,  one-half  per 
cent  each  year  being  the  common  rate  of  pay- 
ment, and  they  loan  about  the  same  percentage 
of  the  value  of  the  lands  mortgaged,  as  do  the 
Landschaften  and  other  land  banks,  and  the 
rate  of  interest  charged  is  the  market  rate, 
into  the  determination  of  which,  of  course, 
the  competition  of  all  other  institutions  enter. 
While  these  institutions  loan  in  the  aggre- 
gate enormous  sums  on  farm  property,  their 
chief  field  of  operations  is  urban  real  estate, 
and  particularly  the  industry  of  residence,  or 
as  we  would  call  it  in  this  country,  apartment- 
house  construction.  It  is  on  this  account  that 
the  period  of  their  most  rapid  development 
coincides  with  that  of  the  recent  rapid  indus- 
trial and  commercial  development  of  Germany, 
which  dates  back  only  to  the  establishment  of 


Investment  Banking  153 

the  Empire  in  1870.  Most  of  them  began 
operations  in  the  decade  1862- 1872,  but  the 
most  rapid  growth  in  the  magnitude  and  scope 
of  their  business  operations  has  come  in  recent 
years. 

In  1899  there  were  forty  institutions  of  this 
kind  in  operation  in  the  German  Empire.  The 
number  at  the  present  time  is  probably  consid- 
erably greater,  since  for  obvious  reasons  com- 
binations among  them  are  not  promoted  by  the 
same  kind  of  economic  pressure  that  in  recent 
years  has  operated  so  efficiently  in  Germany  in 
the  field  of  commercial  banking. 

Two  other  groups  of  German  institutions 
merit  attention  in  this  connection,  namely,  the 
so-called  Schulze-Delitzsch  and  the  Raiffeisen 
Credit  Associations. 

The  Schulze-Delitzsch  societies  were  the 
direct  outcome  of  the  period  of  dearth  and 
famine  through  which  Germany  passed  in  the 
years  immediately  preceding  the  revolution  of 
1848.  The  first  one  was  not  a  credit  associa- 
tion, but  a  cooperative  buying  society,  organ- 
ized by  a  local  judge  named  Schulze  for  the 
aid  of  his  needy  neighbors  of  the  small  trading 
class  in  the  town  of  Delitzsch.  In  1850  a  credit 
association  on  the  same  plan  was  organized. 
Others   followed,   in  rapid   succession  in  and 


154  Banking 

after  the  seventies,  until  at  the  present  time 
they  are  numbered  by  the  thousands  and  their 
members  by  millions,  and  they  are  scattered 
throughout  the  entire  empire. 

The  principle  of  their  organization  is  the 
association  of  a  comparatively  small  group  of 
neighbors,  or  of  people  who  know  one  another 
well,  or  who  may  easily  come  to  know  one  an- 
other well,  by  each  making  a  contribution  to  a 
common  fund  to  be  loaned  out  to  individuals 
on  personal  security  chiefly,  and  which. 
together  with  the  credit  of  the  entire  group, 
may  be  made  the  basis  of  security  for  larger 
funds  to  be  borrowed  on  the  open  market.  They 
are  carefully  organized  on  the  cooperative 
principle,  each  member  having  an  equal  voice 
in  a  general  assembly  which  chooses  a  board  of 
directors  and  a  small  administrative  board,  to 
which  is  intrusted  the  actual  management  and 
administration  of  the  affairs  of  the  society. 

Loans  are  made  to  members  only,  usually 
for  short  periods  of  time,  on  the  personal 
security  of  the  Imrrower  and  of  others  who 
are  willing  to  vouch  for  him,  and  on  the  un- 
usually favorable  terms  which  the  credit  of  the 
entire  organization  and  very  low  costs  of 
administration  render  possible.  The  knowl- 
edge which  each  member  has  of  the  character 


Investment  Banking  155 

and  business  methods  of  his  fellow  members 
who  borrow,  and  of  the  use  to  which  borrowed 
funds  are  put,  and  the  stake  which  each  one 
has  in  the  financial  stability  and  success  of  the 
organization,  bring  the  percentage  of  losses  to 
a  very  low  figure,  and  make  it  possible  for 
these  societies  to  grant  their  members  maxi- 
mum accommodations  at  minimum  prices. 

To  the  funds  accumulated  from  initiation 
fees,  membership  dues  and  the  sale  of  the  asso- 
ciations' credit  have  been  added,  in  constantly 
increasing  amounts  in  recent  years,  the  savings 
of  the  members  themselves.  Many  societies 
have  such  an  amount  of  funds  intrusted  to 
them  in  this  way  that  they  are  not  only  entirely 
freed  from  the  necessity  of  borrowing,  but  are 
obliged  to  seek  opportunities  for  investment 
outside  their  own  group. 

This  condition  of  affairs,  in  addition  to  many 
other  common  interests,  led  to  the  federation 
of  the  Schulze-Delitzsch  societies  into  larger 
groups,  and  these  in  turn  into  state  and  national 
associations,  through  which  surplus  funds  in 
one  could  be  made  to  serve  the  needs  of 
others  inadequately  supplied,  and  through 
which  all  the  societies  could  be  brought  into 
efficient  connection  with  the  general  money 
market  of  the  country.     For  a  number  of  years 


156  Banking 

these  federated  societies  conducted  a  large  cen- 
tral institution,  first  in  Frankfurt  and  after- 
wards in  Berlin,  known  as  the  Deutsche 
Genossenschaftsbank.  In  1904,  however,  this 
institution  was  absorbed  by  the  Dresdener 
Bank,  one  of  the  eight  great  private  banking 
corporations  of  Germany,  which  now  serves  as 
the  central  agency  for  all  these  societies. 

The  membership  of  these  associations  is  not 
restricted  to  any  class  of  persons,  and  they 
actually  include  a  very  large  number  of  small 
farmers.  An  inquiry  made  in  1885  showed 
that  in  545  of  them,  with  a  total  membership 
of  270,808,  there  were  72,994  farmers,  and  that 
one-fifth  of  the  total  loans  of  these  associations 
were  made  to  this  class  of  their  members.  They 
must,  therefore,  be  numbered  among  the  land 
banks  of  the  Empire,  or  at  least  among  the 
institutions  which  are  helping  to  solve  the  credit 
problem  for  the  agricultural  classes. 

The  Raiffeisen  societies  resemble  the 
Schulze-Delitzsch  in  many  particulars  and 
differ  from  them  in  others.  Like  them  they  are 
strictly  cooperative  in  character,  and,  when 
organized  for  credit  purposes,  designed  to 
supply  members  with  loans  on  the  most  favor- 
able possible  terms.  Their  development  was 
also  due  to  the  hard  economic  conditions  of 


Investment  Banking  157 

the  period  immediately  succeeding  the  revolu- 
tion in  1848. 

They  differ  from  the  Schulze-Delitzsch  so- 
cieties chiefly  in  the  following  particulars : 
They  charge  no  initiation  fees  and  do  not 
rely  to  the  same  extent  on  the  proceeds  of 
the  sale  of  shares,  the  amount  of  which  they 
place  at  a  very  low  figure,  often  the  lowest 
permitted  by  law;  they  make  long-period  as 
well  as  short-period  loans,  indeed  the  former 
chiefly ;  they  do  not  pay  dividends  on  their 
share  capital,  but  instead  put  all  profits  into 
reserve  funds  or  prevent  their  accumulation 
by  keeping  the  loan  rates  low ;  they  exer- 
cise more  care  than  do  the  Schulze-Delitzsch 
associations  to  keep  their  societies  small,  laying 
great  emphasis  upon  the  importance  of  per- 
sonal acquaintance  between  members  and  thus 
upon  mutual  watchfulness;  and,  in  their  origin, 
they  were  peasant  organizations  pure  and 
simple,  and  hence  more  strictly  land  banks. 

Their  founder,  F.  W.  Raiffeisen,  Burgo- 
meister  of  a  small  village  in  Westphalia, 
Prussia,  wanted  to  rescue  the  poor  peasants  of 
his  and  other  districts  from  the  clutches  of  the 
usurers,  into  whose  hands  they  had  fallen  and 
by  whom  they  were  being  exploited  in  a  most 
shameful   manner.      Since   it   was   loans   that 


1 58  Banking 

these  people  needed  and  since  their  cash  re- 
sources were  always  very  low  and  in  many 
cases  nil,  he  felt  that  to  require,  as  a  condition 
of  membership,  entrance  fees  and  the  purchase 
of  One  or  more  shares  of  stock,  however  small, 
would  be  fatal  to  the  success  of  his  plans.  He 
also  firmly  believed  that  in  the  integrity,  in- 
dustry, frugality,  and  agricultural  skill  of  these 
people  was  the  basis  for  sound  credit  and  that 
cooperation  was  a  means  by  which  these  ele- 
ments of  sound  credit  could  be  made  available 
and  attractive  on  the  money  market.  At  the 
beginning,  therefore,  no  entrance  fees  or  share 
subscriptions  were  required.  Later  Prussian 
law  made  share  subscriptions  compulsory  and 
they  were,  of  course,  introduced,  but  they  were 
made  so  low,  and  the  acquisition  of  the  money 
for  their  purchase  so  easy,  that  they  have  not 
been  a  serious  obstacle. 

From  the  beginning  Raiffeisen  invited  to 
membership  in  his  societies  the  well-to-do  and 
substantial  people  as  well  as  peasants.  Of 
course  these  people  did  not  require  the  society 
for  the  satisfaction  of  their  own  credit  needs, 
but  Raiffeisen  saw  that  they  would  greatly 
strengthen  the  credit  of  the  societies  and  he 
was  able  to  appeal  to  them  on  philanthropic 
grounds.     This  class  of  people  have  a  leading 


Investment  Banking  159 

part  in  the  administration  of  the  societies  of 
which  they  are  members  and  have  contributed 
greatly  to  their  success. 

At  the  outset  the  Raiffeisen  societies  had  to 
rely  chiefly  on  borrowing  for  the  acquisition 
of  the  capital  needed,  but  with  time  and  suc- 
cess savings  deposits,  surplus  funds  accumu- 
lated out  of  profits,  and  lastly  the  proceeds  of 
the  sale  of  shares  have  played  an  increasing 
role.  At  the  present  time  many  societies  are 
not  obliged  to  borrow  at  all,  and  not  a  few 
have  surplus  funds  which  are  placed  at  the  dis- 
position of  other  societies  which  are  still 
obliged  to  borrow. 

Like  the  Schulze-Delitzsch  societies  the 
Raiffeisen  associations  have  federated.  At 
present  there  are  thirteen  so-called  unions,  and 
at  the  head  of  all  is  a  central  bank  with  head 
office  at  Berlin  and  branches  at  Konigsberg, 
Danzig,  Breslau,  Cassel,  Frankfurt,  Coblenz, 
Brunzwick,  Strassburg,  Nuremberg.  Posen, 
and  Ludwigshafen.  The  central  bank  is  a 
joint-stock  company,  organized  on  the  principle 
of  limited  liability,  the  stock  of  which  is  owned 
by  the  local  societies.  It  formerly  had  close 
relations  with  the  Imperial  Bank,  but  is  now 
associated  with  the  so-called  Centralgenossen- 
schaftskassa,  endowed  by  the  state  of  Prussia. 


160  Banking 

in  such  a  way  that  advances  and  discounts  are 
extended  to  it  on  favorable  terms. 

The  Raiffeisen  societies  rival  the  Schulze- 
Delitzsch  in  the  rapidity  of  their  growth  and 
in  the  role  they  play  in  the  economic  life  of 
modern  Germany.  In  1908  they  numbered 
5,047,  of  which  4,340  were  credit  associations. 
The  collective  balance  sheets  of  these  societies 
in  1907  showed  490,734,834  marks  assets, 
489,234,357  marks  liabilities,  and  a  member- 
ship of  405,819. 

While  Germany  was  the  pioneer  in  the  estab- 
lishment of  land  credit  institutions,  and  while 
such  institutions  have  attained  a  greater  variety 
of  form  and  a  higher  degree  of  perfection  in 
that  country  than  in  any  other,  other  countries 
have  advanced  along  similar  lines  and  now 
have  institutions  and  a  fund  of  experience  well 
worthy  of  study.  The  institutions  of  Germany 
have  in  most  cases  served  as  models  in  these 
other  countries,  the  mortgage  banks  and  the 
Schulze-Delitzsch  and  Raiffeisen  societies  hav- 
ing been  most  frequently  copied.  These  models 
have  been  adapted  to  foreign  conditions  and 
modified  in  interesting  and  instructive  ways  as 
well  as  copied  without  essential  change. 

Among  the  mortgage  banks  developed  out- 
side of  Germany  the  Credit  Foncier  of  France 


Investment  Banking  161 

is  especially  noteworthy.  In  its  organization  it 
was  modeled  after  the  Bank  of  France  and  is 
second  only  to  that  institution  in  the  magni- 
tude of  its  operations  and  the  scope  of  its  in- 
fluence. Its  head  office  is  in  Paris  and  it  has 
at  least  one  branch  in  each  department.  Its 
capital  stock  owned  by  private  parties  amounts 
to  about  $40,000,000,  its  surplus  to  over  $4,- 
000,000,  its  loans  secured  by  mortgage  to  over 
$400,000,000,  and  its  total  resources  to  about 
$1,000,000,000. 

Like  the  German  mortgage  banks,  it  secures 
the  greater  part  of  its  loan  funds  through  the 
issue  of  mortgage  bonds  and  a  large  percentage 
of  its  loans  are  made  on  mortgage  security  for 
long  periods  of  time  and  are  repayable  on  the 
annuity  plan.  However,  it  transacts  a  greater 
variety  of  business  than  does  the  typical  mort- 
gage bank  of  Germany.  It  loans  on  city  and 
farm  real  estate  and  to  communes,  and  it 
transacts  a  large  commercial  banking  business, 
though  this  is  distinctly  a  side  issue,  incorpo- 
rated with  its  other  business  in  order  to  give 
profitable  employment  to  funds,  sometimes 
large  in  amount,  which  are  temporarily  on  hand 
awaiting  investment. 

At  various  times  it  has  absorbed  competing 
institutions   and    at   times    it    has   established 


1 62  Banking 

collateral  institutions  to  transact  lines  of  busi- 
ness for  which  its  own  constitution  and  legal 
limitations  did  not  fit  it.  Among  these  the  most 
important  are  the  Credit  Agricole  and  the  Fon- 
der Algierienne.  It  was  obliged  ultimately  to 
absorb  and  liquidate  the  former,  but  the  latter 
still  flourishes  in  the  colony  of  Algiers. 

Mortgage  banks  have  also  gained  a  footing 
in  most  of  the  other  countries  of  continental 
Europe.  In  Italy  they  passed  through  a  period 
of  storm  and  stress,  owing  to  their  connection 
with  the  issue  banks  of  that  country  and  the 
consequent  confusion  between  commercial  and 
investment  banking  which  resulted,  but  they 
have  recently  been  established  on  an  independ- 
ent basis  and  are  now  developing  along  right 
lines  and  with  apparent  success. 

The  Schulze-Delitzsch  and  Raiffeisen  socie- 
ties have  been  imitated  in  Austria,  Hungary, 
Belgium,  Switzerland,  and,  to  some  extent,  in 
France  and  India.  The  so-called  "  Banche 
Populari "  and  "  Casse  Rurali "  of  Italy  are 
respectively  modified  forms  of  these  two  Ger- 
man types,  and  rank  among  the  most  important 
means  employed  in  that  country  for  the  im- 
provement of  the  condition  of  the  peasants  and 
small  tradesmen.  State,  provincial,  and  com- 
munal aid  for  these  institutions  has  been  more 


Investment  Banking  163 

frequently  evoked  and  more  extensively  em- 
ployed outside  than  inside  of  Germany,  and 
other  important  modifications  of  the  German 
prototypes  have  been  made  in  Italy  and  else- 
where. 

5.  Stock  Exchanges 

An  essential  part  of  the  machinery  of  invest- 
ment banking  is  the  stock  exchange.  This  is  a 
place  where  the  buyers  and  sellers  of  securities 
or  their  agents  regularly  meet  for  the  transac- 
tion of  business.  It  may  be  a  portion  of  a  street 
or  a  market  place  or  a  room  in  a  building.  A 
fully  equipped  modern  exchange  contains  a 
large  room  equipped  with  telegraphic  and  tele- 
phonic communication  with  the  most  important 
parts  of  the  country  in  which  it  is  located  and 
of  the  world,  with  apparatus  for  registering 
prices  and  easily  communicating  information 
to  its  members,  and  with  the  offices  needed  for 
the  accommodation  of  the  clerks  and  other 
employees  required.  Either  by  posts  or  in  some 
other  manner  the  precise  places  in  it  in  which 
each  security  or  group  of  securities  is  to  be 
dealt  in  is  also  usually  indicated. 

The  purpose  of  the  stock  exchange  is  to 
facilitate  and  to  regulate  dealings  in  securities. 
It   facilitates   such   dealings   by   providing   as 


164  Banking 

nearly  perfect  means  as  is  possible  for  putting 
buyers  and  sellers  into  communication  with 
each  other,  and  for  collecting  and  making  avail- 
able to  them  the  information  they  need.  To 
this  end  they  provide  for  daily  meetings  at 
fixed  hours;  they  make  and  publish  lists  of  the 
securities  dealt  in;  they  speedily  record  and, 
through  the  telegraph  and  the  telephone,  com- 
municate to  all  quarters  of  the  globe  the  prices 
at  which  securities  change  hands ;  and  through 
the  meeting  room  equipped  as  before  described 
they  make  it  possible  for  buyers  and  sellers, 
no  matter  where  located,  to  communicate  with 
each  other  in  a  very  short  period  to  time.  They 
regulate  such  dealings  by  establishing  and 
rigidly  enforcing  rules  and  regulations  for  list- 
ing, transferring,  clearing,  and  paying  for 
securities  and  for  other  matters  pertaining  to 
the  conduct  of  their  members. 

These  institutions  serve  investment  banks  as 
well  as  private  investors,  constituting  the 
machinery  which  connects  them  all.  They  thus 
enlarge  the  area  and  scope  of  the  markets  for 
securities,  and  greatly  increase  the  mobility  of 
capital.  Without  them  the  surplus  savings  of 
one  locality  would  only  very  slowly  and  witli 
difficulty  find  their  way  to  other  localities  where 
they  are  needed,  with  the  result  that  capital 


Investment  Banking  165 

would  lie  idle  or  be  very  inefficiently  employed 
in  some  places  while  in  others  natural  and 
human  resources  would  be  undeveloped  or  very 
inefficiently  developed. 

Existing  stock  exchanges  differ  considerably 
in  the  manner  in  which  they  are  organized  and 
managed,  in  methods  of  doing  business,  and  in 
the  scope  of  their  operations.  Some  of  them 
are  incorporated  and  others  unincorporated; 
some  restrict  their  membership  to  a  prescribed 
number,  others  admit  as  many  as  are  able  and 
willing  to  comply  with  the  conditions  imposed; 
some  are  local  in  their  scope,  some  national,  and 
others  international.  In  this  country  all  the 
exchanges  deal  in  local  securities  chiefly,  except 
the  one  in  New  York  City,  which  is  national  in 
its  scope.  The  London  exchange  does  a  larger 
business  in  international  securities  than  any 
other,  but  the  Paris  and  Berlin  exchanges,  as 
well  as  those  located  at  the  other  important 
European  capitals,  and  the  one  at  New  York 
share  in  it  to  a  greater  or  less  degree. 

Stock  exchanges  have  suffered  in  reputation, 
and  their  real  functions  and  merits  have  been 
obscured  by  the  abuses  to  which  they  have  been 
subjected.  Connected  with  their  legitimate 
business  of  facilitating  the  investment  of  capi- 
tal, various  forms  of  speculation  have  developed 


1 66  Banking 

which  in  some  cases  have  degenerated  into 
gambling  pure  and  simple.  The  better  man- 
aged ones  have  striven  to  rid  themselves  of 
these  abuses,  and  in  some  countries,  notably  in 
Germany,  legislative  bodies  have  taken  a  hand. 
The  results,  however,  have  proved  only  par- 
tially  successful. 

Some  forms  of  speculation  are  not  only 
legitimate  but  necessary  in  modern  business 
life,  and  these  shade  into  the  illegitimate,  un- 
necessary, and  positively  harmful  forms  by 
such  short  and  easy  steps  as  to  render  it  diffi- 
cult, and  perhaps  impossible,  to  draw  a  line 
between  the  two  which  can  serve  as  a  guide 
for  regulations  of  an  administrative  or  legis- 
lative kind. 

6.  Some  Defects  in  Our  Investment  Banking 
Machinery 

A  comparison  of  our  investment  banking 
machinery  with  that  of  European  countries, 
especially  Germany,  reveals  important  differ- 
ences. Among  these  the  most  notable  are  the 
wide  use  there  and  the  almost  complete  absence 
here  of  the  following :  (a)  the  resort  to  cooper- 
ation as  a  means  of  revealing  and  making  avail- 
able the  basis  for  credit  of  large  numbers  of 
people  who  lack  capital  but  could  use  it  to  the 


Investment  Banking  167 

advantage  of  themselves  and  of  the  nation; 
(b)  the  long-period  mortgage  loan  repayable 
on  the  annuity  plan  and  the  mortgage  bond  as 
a  means  of  accumulating  capital  for  such  loans; 
and  (c)  the  cooperation  of  the  state  and  other 
public  bodies  and  of  capitalists  and  philan- 
thropically  disposed  persons  in  developing  the 
credit  possibilities  of  the  masses  and  in  direct- 
ing the  flow  of  proper  portions  of  the  stream 
of  capital  in  their  direction. 

In  the  development  of  investment  banking 
institutions  in  this  country,  individual  initiative 
prompted  by  self-interest  has  been  the  chief, 
and  except  in  the  case  of  savings  banks,  the  sole 
motive  force.  The  result  is  that  most  of  them 
have  been  organized  in  the  interests  of  lenders 
rather  than  borrowers  and  serve  best  the  pur- 
poses of  big  business  and  of  persons  already 
possessed  of  large  credit  by  virtue  of  their 
wealth  or  their  business  reputations.  Under 
these  conditions,  while  enormous  amounts  of 
capital  in  the  aggregate  have  been  invested  in 
agriculture  and  urban  real  estate,  the  former 
has  suffered  relatively  in  comparison  with 
transportation,  manufacturing,  and  speculation. 

Contributory  causes  in  the  development  of 
this  situation  have  been  the  great  need  for  cap- 
ital for  the  development  of  our  transportation 


1 68  Banking 

system,  the  stimulation  of  manufactures  by 
high  protective  duties,  and  the  enormous  area 
of  our  public  domain  which  was  given  or  sold 
to  settlers  on  very  easy  terms.  Inasmuch  as  our 
transportation  system  and  our  manufacturing 
industries  have  now  attained  a  high  degree 
of  development,  our  public  domain  has  been 
nearly  exhausted,  and  land  values  and  the  cost 
of  living  are  rapidly  rising,  the  needs  of  agri- 
culture are  pushing  themselves  into  the  fore- 
ground, and  we  are  beginning  to  look  to  Euro- 
pean experience  for  suggestions  regarding  the 
best  methods  of  diverting  to  that  industry  a 
larger  part  of  our  rapidly  accumulating  capital 
resources. 

There  are  obvious  difficulties  in  the  way  of 
the  application  of  cooperation  to  the  solution 
of  the  problem  of  agricultural  credit  in  this 
country.  In  spite  of  the  fact  that  immigration 
is  constantly  bringing  to  us  people  from  the 
very  foreign  countries  in  which  cooperative 
credit  associations  flourish,  our  agricultural 
population  is  still  dominated  by  the  spirit  of 
individualism  which  has  been  and  is  one  of  our 
dominant  national  traits.  Our  farmers  are 
also  more  widely  scattered  than  is  the  case 
in  Europe,  and  consequently  less  closely  knit 
together  in  social  units.     Their  holdings  are 


Investment  Banking  169 

also  larger,  their  capital  needs  greater,  and 
their  business  instincts  more  highly  developed. 

There  seems  to  be  no  good  reason,  however, 
why  the  joint-stock  mortgage  bank  should  not 
flourish  here  as  well  as  in  Europe.  It  is  a 
purely  private  business  enterprise  of  the  kind 
with  which  we  are  perfectly  familiar.  The 
mortgage  bond  ought  to  appeal  to  our  in- 
vestors, many  of  whom  have  exhibited  a  strong 
predilection  for  mortgage  security  and  real 
estate  investments,  and  long-period  mortgage 
loans,  repayable  on  the  annuity  plan,  would 
meet  the  needs  of  many  land  purchasers  and  of 
people  who  need  to  invest  considerable  sums 
in  drainage,  irrigation  works,  etc.,  better  than 
our  present  methods.  In  most,  if  not  all,  of  our 
states,  trust  companies  could  develop  these  new 
lines  of  finance  without  prejudice  to  the  other 
branches  of  their  business. 

The  use  of  state,  county,  and  municipal  sub- 
sidies or  credit  in  enterprises  of  this  kind  is 
rendered  difficult,  if  not  impossible,  in  this 
country,  by  strong  prejudice  against  the  use 
of  public  funds  in  private  enterprises,  and  in 
some  states  by  constitutional  prohibitions.  This 
prejudice  is  based  upon  unfortunate  experi- 
ences, and  is  at  least  partially  justified  by  the 
laxness  of  our  administrative  methods  and  the 


i  /O  Banking 

prevalence  of  graft,  which  expose  us  to  the 
danger  of  the  improper  use  of  public  funds 
devoted  to  enterprises  of  this  kind.  There  is 
no  reason,  however,  why  our  states  should  not 
take  the  initiative  in  the  improvement  of  our 
investment  banking  machinery  and  why  private 
capitalists  and  philanthropists  should  not  turn 
some  of  their  energy  into  this  channel. 

Suggestion  and  leadership  are  needed  in  this 
field  quite  as  much  as  legislation  tending  to 
restrict  and  regulate  the  operations  of  existing 
institutions. 


REFERENCES 

The  following  books  are  comprehensive  in 
character,  treating  most  of  the  subjects  covered 
in  the  foregoing  chapters : 

Macleod,    H.    D.,    Theory    and    Practice    of 

Banking. 
Gilbart,    J.    W.,    History    and    Principles    of 

Banking. 
Bagehot,  Walter,  Lombard  Street. 
Dunbar,  Charles  F.,  History  and  Theory  of 

Banking. 
Scott,  Wm.  A.,  Money  and  Banking.    Rev.  Ed. 
White,  Horace,  Money  and  Banking. 
Fisk,  A.  K.,  The  Modern  Bank. 

The  subject  of  clearings  and  the  exchanges  are 
discussed  in  the  following  books : 

Cannon,  J.  G.,  Clearing  Houses. 

Clare,  George,  The  A,  B,  C  of  the  Exchanges. 

Clare,  George,  A  Money  Market  Primer  and 

Key  to  the  Foreign  Exchanges. 
Margraff,  A.  W.,  International  Exchange. 
Escher,  F.,  Foreign  Exchange. 

171 


172  References 

The  following  cover  the  history  and  present 
condition  of  banking  in  the  leading  countries : 

Conant,  C.  A.,  Modern  Banks  of  Issue. 

Knox,  J.  J.,  A  History  of  Banking  in  the  United 

States. 
Sumner,  Wm.  G.,  A  History  of  Banking  in  the 

United  States,  being  Vol.  I  of  a  History  of 

Banking  in  all  the  leading  nations. 
Kirkbride  &  Sterrett,  J.  E.,  The  Modern  Trust 

Company,  Its  Functions  and  Organization. 
Breckenridge,  R.  M.,  The  History  of  Banking 

in  Canada. 
Laughlin,  J.  L.,  Editor,  Banking  Reform. 
Johnson,  J.  F.,  The  Canadian  Banking  System. 
Withers,  Hartley,  Palgrave,  R.  H.,  and  others, 

The  English  Banking  System. 
Liesse,  A.,  Evolution  of  Credit  and  Banks  in 

France. 
National  Monetary  Commission,  The  Reichs- 

bank,  1876- 1900. 
Riesser,  J.,  The  German  Great  Banks  and  Their 

Concentration. 

On  investment  banking  see : 

Wolff,  H.,  People's  Banks. 
Peters,  E.  E.,  Co-operative  Credit  Associations. 
Hamilton,  J.  H.,  Saving  and  Savings  Institu- 
tions. 
Pratt,  S.  S.,  The  Work  of  Wall  Street. 
Conant,  C.  A.,  Wall  Street  and  the  Country. 


INDEX 

"Acceptance"  credit  and  lines,  103 

Accommodation    loans,    12,    13 

Accounts    overdrawn,    1G 

Agriculture,  capital  for,  168;   individualism  in,  168 

Assets,   prior   lien  on,   56;    special,   57 

Balances,  16,   17,  23,  28 

Banche   Popular i,    162 

Bank  of  England,  104-111 

Bank   reserves,   35-40 

Bank   of  France,   111-119 

Banker's  banks,  9;  bills,  33,  34;  most  valuable  assets, 
61 ;  making  loans,  86 

Banking,  act,  54,  78 ;  adequacy  and  economy  of  service, 
62,  66;  branch,  64,  65;  business,  9;  commercial,  nature 
and  operation  of,  11-67;  commercial  in  the  United 
States,  68-100;  commercial  in  other  countries,  101-135; 
Canadian,  126-135;  defects  and  reforms  in  banking 
systems,  97-100;  English,  104-111;  French,  111-119; 
functions  in  single  institutions,  144;  German,  119-126; 
incorporation,  66;  investment,  136-170;  Kansas  "blue 
sky  laws,"  146;  problems  of  commercial,  35;  reserve, 
78;  services  rendered  by,  1-3;  Wisconsin  regulations, 
146;    Local,  62,  63 

Bank  notes,  see  notes 

Banks,  bond  lmus.'s,  6;  Canadian,  126-135;  central  of 
Kuro|ic,  101;  central  reserve.  78;  classified,  6j  classi- 
fication of  national,  54;  collect  inns,  22;  commercial, 
6,  7;  cooperative,  139;  correspondent,  24,  25;  Bug- 
land,  bank  of,  L04-111;  European  land  banks,  147-163; 

European    central,    9;    federal,    8;    federal    reserve,    9S- 

100;  France,  bank  of,  Lll-119;  French  land,  L60  163; 
functions  of,  4 ;  German  Imperial,  119-123;  German 
land,  147-163;  Incorporated,  7;  Inspection  of,  59;  in- 
terest charges,  14;  investment,  6,  7;  Italian  land, 
160-163;  joint  stock,  7;  land,  6;  loan-making,  86; 
municipal,  L39;  national,  8,  70-75;  oote  Issue  priv- 
ileges, 37,  38;  o\'  issue,  20,  21;  postal  Baving,  139: 
private,    7;    protection   against   unsound   practices  of, 

173 


i 74  Index 


46-62;  real  estate,  6,  52;  savings,  6,  136-141;  services 

rendered  by,  1-3;  state,  9,  68-70;  supply  currency,  22; 

trustee,   139 
Berlin  stock  exchange,  165 
Bills   of  exchange,    12,    17;    documented,   42 
' '  Blue  sky  laws ' '  of  Kansas,   146 
Bond  houses,    144-147 

Bonds,  government,  96,  97;  mortgage,  148,  150,  169 
Bonds  and  stocks,  not  liquid  securities,  53 
Book   accounts,    12 
Branch  banking,  62,  64,  65 
Bullion,  81,   82;   in   Canada,   132;   in  England,   105;   in 

France,  113 ;   in  Germany,  122 
Buying  and  selling  on  time,  11,  12 

Cables  in  foreign  exchange,  33 

Canadian  banking  system,  126-135 

Capital  and  surplus  requirements  for  banks,  46-48 ;  stock, 
47,   48 

Cash,  supply  of,  35-40;  demands  on  banks,  55;  re- 
sources, 29 

Casse   Rurali,    162 

Central  banks  of  Europe,  8,  9,  65,  101;  England,  104- 
111;  France,  111-119;   German,  119-123 

Charters,  8;  special,  66,  67 

Checking  accounts,  15,  20,  21,  24,  35 

Checks,  15,  16,  21-24;  abroad,  36 

Chicago,  clearing  center,  24;   central  reserve  banks,  78 

Clearing  house,  22-24;  center  in  New  York,  80 

Coin,  21;  and  bank  reserves,  38;  in  England,  109;  in 
France,  117;  in  Germany,  121,  122;  standard  and 
subsidiary,   21 ;   supply,  40 

Collections,  22,  25 

Commercial  banking,  collections,  22;  currency,  21,  22; 
domestic  exchange,  25;  nature  and  operations  of,  11- 
67;  other  countries,  101-135;  problems  of,  35;  prom- 
issory notes,  19;  protection  against  unsound  practices 
of,  46-62;  savings  accounts,  44;  in  the  United  States, 
68-100 

Commercial  paper,  11-14;  discount  of,  14,  15,  17;  and 
investment  paper,  41,  42;  liquid  security,  53;  market 
for,  100 

Competition  in  banking,  83 

Comptoir  d'Escompte  de  Paris,  115,  116 

Conflict  of  functions  and   laws,  82 


Index  175 


Cooperative   banks,    139 

Correspondent  banks,   24,   25 

Credit  "acceptance"  line,  103;  balance,  16, 18-20,  23,  25; 
cooperation  in,  166-168;  department  in  banks,  43,  86; 
inflation  of,  87;  "line"  of,  16,  85,  86;  subsidies, 
state,  county,  and  municipal,  169;  system,  11-13 

Credits,  forced  liquidation  of,  49 

Credit  Agricole,  162;  Foncier,  113;  Industrielle  et  Com- 
mercial,  115,   116;    Lyonnais,   115,   116 

Crisis,  commercial,   19,  31,  88 

Currency,   21,  22;   lack  of  elasticity,   95-97 

Debt  paying,   13,   14 

Debits,  15-18 

Demand  in  foreign  exchange,  33,  34 

Deposits,  2-4 

Depositors,  mutual  insurance  of,  60-62 

Discount,  defined,  14;  loans  and  discounts,  selection  of, 
40-43 ;  loans  and  rates,  44 ;  operation  of,  13 ;  rate, 
Canadian,  128,  129;  bank  of  England,  108;  bank  of 
France,  113;  reserve  system,  95,  97;  stopped,  30 

Discounted  paper,  14,  15,  17-19,  55 

Documented  bill  of  exchange,  42 

Domestic  exchange,  25 

Drafts,  16,  27,  28;  foreign  payments,  31 

England,  bank  of,  9,  104-111;  banking  system,  104-111 
foreign  and  colonial,  108;  joint  stock  banks,  106 
metropolitan,  107;  private,  108;  provincial,  107 
reserve  system,  108 

Europe,  commercial  banking  in,  101-126;  central  banks 
of,  101-126;   land  banks,  147-163 

European  investment  banking  machinery,  166 

Exchange  operations,  11-13;  checks,  22-24;  domestic, 
25-31;   foreign,  31-34 

Federal  Reserve  Banks,  98-100;  Federal  Reserve  Board, 

99,  100 
Foncier  Algierienne,  162 
Foreign  exchange,  31-34;  par  of,  31,  32;  classes  of  bills 

used,  33 
France,  bank  of,  9,  111-115 
French  banking  system,  111-119 


176 


Index 


German  banking  system,  119-126;  hypothekenaktien- 
banken,  151,  152 ;  investment  banking  machinery,  166 ; 
land  and  mortgage  hanks,  147-161 ;  landschaften,  147- 
149;  Schulze-Delitzsch,  153-162;  Raiffeisen,  156-162 

Germany,  bank  of,  9,  119-12:5 

Gold  element  of  currency,  5,  96 ;  points,  32,  33 ;  and 
silver  coin  in  England,  105,  106;  in  France,  113; 
Canada,   133 

Incorporation,   7 ;    should  be  required,  66 

Independent  treasury  system,  75-78 

Inflation,  49-53,  56-59;  of  credit,  87 

Inspection  of  banks,  59,  60 

Insurance,  mutual  of  depositors,   60,   62 

Investment,  banking,  136-170;  commercial  paper,  41,  42; 
confined  to  liquid  securities,  52;  defects  in  machinery, 
166;  improvement  of  machinery,  170;  paper,  18,  35, 
41,  55;  of  surplus  funds,  3 

Italy,  land  banks,  162,  163 

Joint-stock  mortgage  banks,  169;  English  joint-stock 
banks,   106;    German,   151-159 

Kansas  "blue  sky  laws,"  146 

Land  banks,  147-163 

Letters  of  credit,  21 

"Line"  of  credit,  16,  85,  86 

Liquidation,  forced,  19,  88;  of  credits,  49,  50;  protec- 
tion against,  52 

Liquid  securities,  53 

Loan  operations,  85-88 

Loans,  2,  3,  15,  86;  and  discounts,  selection  of,  40-43; 
Canadian  system,  128,  129;  fluctuations,  97;  German 
land  bank,  147-162;  in  the  interest  of  big  business, 
167;  limits  to,  52,  55;  long-term,  2;  pernicious  prac- 
tice of  national  banks,  83;  and  reserve  system,  95; 
short  term,  2 

Local  banking,  62,  63 

London  stock  exchange,  165 

Mints,  5 

Monetary  commission,  97,  98 

Money  of  the  United  States,  95 


Index  i J? 


Mortgage  banks,  169;  France,  160-162;  Germany,  148- 
163  ;  Italy,  162  ;  mortgage  bonds,  169 ;  mortgage  loans, 
long  period,   167 

Municipal  banks,  139 

National  banks,  8,  9,  54,  70-75,  80,  82;  federal  reserve, 
98,  99;  money  in  vaults,  91;  notes,  96;  pernicious 
loan  practices,  83;  subscribed  to  federal  reserve 
banks,  98 

National  Keserve  Association,  98 

New  York  City,  as^ay  office,  81;  central  reserve  bank, 
78;  clearing  center,  24,  80,  81;  stock  exchange,  81, 
82,  92,   165 

Notes,  bank,  19-21 ;  central  banks  of  Europe  and  supply 
of,  102;  Canadian,  126-133;  bank  of  England,  105; 
of  France,  117,  118;  of  Germany,  121;  issue  of,  19- 
21 ;  issue  privileges,  37,  38 ;  government,  39 ;  limita- 
tion of  issue,  58 ;  promissory  notes,  43 ;  regulations 
regarding,  52;  safeguarding  issue,  56;  volume  of 
United  States,  96 

Oklahoma,  mutual  insurance  plan,  60 
Overdrafts,  16 

"Panicky"  conditions  and  feeling,  94,  95,  97 

Par  of  exchange,  31,  32 

Paris  stock  exchange,  165 

Passbook,   15,   16 

Postal  savings  banks,  139,  141 

Promissory  notes,  12,  14,   19-22,  43 

Prior  lien,  on  assets,  56,  58 

Protection   against   unsound   practices   of   banks,   46-52; 

59-61 
Publicity,  a  safeguard,  59 

4 

Rate   of    discount,    law    in    France,    118;    of   exchange, 

2ti,  27 
Rates,  44-46;  raising  on  loans  ami  discounts,  29 
Real  estate  and  banks,  52 
Reserve    banks,    Federal,    98-100;    central    reserve,    78; 

cities,  24,  78 
Reserves,     administration     of     funds,     100;     bank,     36  J 

English     system,     108-110;      in     national     banks.     7.'> ; 

operations   of   system,   91-94:    regulations    regarding, 

52,   '54;     secondary,    35-40;     in    slate    banks,    69;     in 
country  banks,  73 


I 78  Index 


Safety,  in  savings  banks,   140;   fund,  56,   57 

Savings  banks,  6,  9;  denned,  139 

Saving  and  saving  institutions,  136-141 

Secretary  of  the  Treasury  and  surplus  funds,  88-90 

Securities,  dealings  in  the  stock  exchange,  163,  164 

Security,  liquid,  53 

Silver  dollars,  96 

Sixty-day  bills  in  foreign  exchange,  33,  34 

Societ§  Algerienne,  114 

Societe  Generale,  115,  116 

State  banks,  9,  68-70,  79,  82;  and  Federal  reserve,  99 

St.  Louis,  central  reserve  bank,  78;  clearing  center,  24 

Stock  exchanges,  163-166 

Stockholders,  liability  of,  46-48 

Surplus,  17,  47 

Trade  or  mercantile  bills,  34 

Treasury  of  the  United  States,  75-78;  operations,  88-90 

Trust  companies,  9,   141-144 

Trustee  banks,    139 

United  States,  notes,  volume  of,  96;  subtreasury,  80,  81; 

treasury,  75-78 
Units  of  value  and  foreign  exchange,  31 

Vouchers,  23 

Wisconsin,  regulation  laws,  146 


This  book  is  DUE  on  the  last 
date  stamped  below 


U2L 


3      1956 


feia 


5m-6,'41(3644) 


UNIVERSITY  OF  CALIFORNIA 

AT 

LC3  ANGELES 

LIBRARY 


3  1158  00407  4364 


UC  SOUTHERN  REGIONAL  LIBRARY  FACILITY 


AA    001  146  002    9 


